The benefit of aging: Catch-Up Contributions

In the most recent episode of The Field Guide Podcast, Brian Colvert, CFP®, takes a fresh look at aging – not as a decline, but as a time brimming with opportunities, especially when it comes to building a secure retirement. Brian dives into the often-underutilized benefits of increasing contributions to retirement accounts as you get older, demonstrating how these seemingly small tweaks can significantly impact your financial future.

Listen Now:

iTunes | Spotify | iHeartRadio | Amazon Music | Castbox

Leveraging Catch-Up Contributions: A Detailed Look:

One of the perks of aging is the ability to contribute more to retirement accounts like IRAs, 401(k)s, and HSAs. Let’s break down the specifics and explore why maximizing these contributions is crucial.

IRAs and Roth IRAs: The standard contribution limit for both Traditional and Roth IRAs for 2024 sits at $7,000. >> Click here to see this year’s limits << However, individuals aged 50 and above are eligible for Catch-up contributions, allowing them to add an extra $1,000, bringing their total contribution to a substantial $8,000. Don’t let high income discourage you; strategies like the Backdoor Roth conversion can help you take advantage of these benefits, even if your income exceeds the Roth IRA contribution limits. Here’s a deeper dive into the backdoor Roth conversion:

Backdoor Roth Conversion: A Backdoor Roth is a strategy that involves contributing to a traditional IRA and then converting those funds to a Roth IRA. There are tax implications associated with this conversion, but for those who wouldn’t qualify for a direct Roth IRA contribution due to income restrictions, it can be a valuable way to access the tax-free growth benefits of a Roth IRA in retirement.

Company Plans: Similar benefits exist for company-sponsored plans like SIMPLE IRAs and 401(k)s. Catch-up contributions are available for those over 50, allowing them to significantly increase their contributions and accelerate retirement savings. Let’s explore some additional considerations for company plans:

Employer Matching: Many employers offer matching contributions on employee contributions to retirement plans. This essentially translates to free money for your retirement. Be sure to contribute at least enough to capture your employer’s full match. It’s like leaving free money on the table if you don’t!

Investment Options: Company plans often offer a variety of investment options within the plan. Understanding your risk tolerance and investment time horizon is crucial when choosing how to allocate your contributions within the plan. We recommend seeking guidance from a CERTIFIED FINANCIAL PLANNER™ regarding your best investment options.

The Power of Compounding Interest with Your Catch-Up Contributions

Here’s where the magic truly happens: compounding interest. Even seemingly small additional contributions can snowball into a significant sum over time. Consider this: a $1,000 extra contribution to an IRA each year, consistently invested for 15 years with a moderate 6% rate of return, could grow into over $23,000. This is the magic of compounding interest working in your favor. Let’s delve a little deeper into the concept of compounding interest:

Exponential Growth: Compound interest allows your money to grow exponentially over time. Your earnings not only come from your initial contributions but also from the interest earned on those contributions. This creates a snowball effect, accelerating the growth of your retirement savings.

Time is Your Ally: The longer your money is invested, the greater the impact of compounding interest. Starting to contribute to retirement savings early and taking advantage of catch-up contributions later allows you to maximize the power of compounding interest.

HSA: A Tax-Advantaged Powerhouse – Unveiling the Benefits

The benefits extend beyond traditional retirement accounts. HSAs (Health Savings Accounts), often overlooked in retirement planning, offer additional avenues for saving. Individuals aged 55 and above can contribute an extra $1,000 on top of the standard limits as of 2024.

>> Click here to see this year’s limits <<

Let’s explore the unique advantages of HSAs:

Triple Tax Advantage: HSAs boast a unique “triple tax advantage.” Contributions are tax-deductible, investment earnings grow tax-free, and qualified medical withdrawals are tax-free. This makes HSAs a powerful tool for saving for future medical expenses while minimizing your tax burden.
Portability: HSAs are portable, meaning the funds belong to you, not your employer. You can retain your HSA even if you change jobs, providing long-term financial security for healthcare costs.

Embrace the Silver Lining:

Growing older comes with its challenges, but it also unlocks valuable opportunities to solidify your financial future. By maximizing catch-up contributions and strategically utilizing retirement accounts, you can pave the way for a secure and comfortable retirement. Remember, you’re not alone in this journey. If you have any questions or need guidance on your retirement planning path, don’t hesitate to reach out.

Taking Action:

Catch-Up Contributions are just the start. Here are some actionable steps you can take today:

Schedule a consultation with a CERTIFIED FINANCIAL PLANNER™: Discuss your retirement goals and explore personalized strategies to maximize catch-up contributions and retirement savings.
Research retirement account options: Understand the contribution limits, tax implications, and investment options for IRAs, Roth IRAs, 401(k)s, and HSAs.
Review your current contributions: Analyze your current contributions to retirement accounts and consider increasing them to take advantage of catch-up provisions.
Automate your contributions: Setting up automatic contributions ensures you’re consistently saving towards your retirement goals.

By taking these steps and embracing the opportunities that come with age, you can transform your retirement from a distant dream into a fulfilling reality.

IRA vs 401k: What’s the Difference:

There are some common misconceptions about the difference between an IRA (Individual retirement account) and a 401k plan. While these two are very similar there are some distinct differences that make each unique.

Before we tackle the difference between an IRA and a 401k it’s important to note that these are not investments. They are simply accounts. Just because you have an account open does not mean you have an investment that will grow and help fund your retirement. Much the same way that just because you own a refrigerator doesn’t mean you actually have any food in it. You have to add to it.

To continue with this analogy… in your fridge, you can have a variety of different types of food (juice, pickles, eggs, beer, and anchovies- if you’re into that sort of a thing). In an IRA and 401k you can have different investments too. Such as stocks, bonds, mutual funds, ETFs, commodities, real estate, and more. You can also change or “throw out” the investments in your IRA or 401k if you’ve left them in the back of the fridge for too long. You know like that 3lb. jar of mayo you bought for that party that one time.

Now that you are hungry, let’s get to the dive-in.

Overview of an IRA vs. 401K:

You probably know fundamentally that saving for retirement is one of the single best things you can do financially. You don’t want to rely on social security, you don’t want to run out of money, you don’t want to be a financial burden to your children, and you want to enjoy your golden years. All great reasons to have a retirement plan! So which retirement plan is best for you?

Both IRAs and 401Ks have tax benefits and are among the most common defined contribution plans. The good news is that you don’t have to choose one over the other. To maximize your retirement savings, you can and should, if possible, contribute to both an IRA and 401k.

The key to note is that a 401k, named for the section of the tax code that discusses it, is an employer-based plan and an IRA is an individual retirement plan. Got it?

First up let’s look at how a 401K and IRA are alike.

The Similarities:

Both allow you to put money in on a tax-deferred basis. Meaning that taxes are not due at the time when you add money. For example, if you make $50,000 and decide to invest $2,000 of it into your IRA or 401k, the $2,000 is not going to be part of your taxable income.
Your money within an IRA or 401k can be invested in a variety of ways.
The money that is invested is allowed to grow tax-deferred. You do not have to pay taxes on the gains from your investments until you take the money out. If you make $1,000 off of your $2,000 investment, you now have $3,000 in your account and you will not have to pay taxes on that gain until you withdrawal the money.
When you do withdrawal the money for whatever amount it will be considered part of your taxable income. You will own taxes on the withdrawal amount. Let’s say you withdrawal the $2,000 and your current annual income is $50,000 after the withdrawal your taxable income will be $52,000.
Since an IRA and 401k are designed for retirement the money that you invest is not supposed to withdraw until after the age of 59 ½. You read that correctly -the government added in a half, well, because your inner 6-year-old knows it’s that important. If you withdraw the money prior to 59 ½ you will pay a 10% penalty on the money plus the amount withdrawn is now part of your taxable income.
Also, the government mandates that at age 73 you have to take out a Required Minimum Distribution (RMD). Basically, they tell you the amount that you must pay taxes on. Quick note, if you are still employed at age 73 and not the owner of the company you can delay your RMDs.

The Differences:

While an IRA and a 401k have many similarities, they do differ in a few very key areas. The main one is that an IRA is an Individual Retirement Account, so it is yours and yours alone. Anyone can have one. A 401k is company-sponsored, so you can only participate in it if your employer offers one. Some other key differences are:

Since a 401k is employer-sponsored, typically the employer will match a percentage of their employees’ contributions up to a certain limit or percentage. There is no option for this in an IRA.
Consequentially because a 401K is employer-sponsored your investment options are limited to what the employer offers. Whereas an IRA will allow you to have more variety in terms of stocks, bonds, real estate, etc.
Loan or hardship withdrawals are available for 401ks. However, IRAs generally do not permit loans or early withdrawals.
An IRA has certain income limits and a 401k does not.
Finally, the contribution limits are different and change from year to year. Feel free to give us a call to learn about the current years’ limits.

Difference Between an IRA and 401k- A Venn Diagram

Which is Right For You?

It depends really. If you have the option of putting your money into an employer-sponsored 401k or an IRA you should do both. Max them out if possible. We recommend prioritizing the 401k first especially if your employer offers a match and then adding to an IRA if you are within the income limits.

This hopefully gives you a good overview of the differences between an IRA and a 401k. While there are many factors to consider, the most important thing to remember is that both are great tools to use to help achieve your retirement goals.

Are you interested in learning about a Roth? We’ve got a great article here for you.

Have other questions? Please setup a call with us HERE!

Tag: IRA

The Power of Catch-Up Contributions