Hey everyone, it’s Finance Fridays again and this is going to be a relatively short post about Catchup Contributions.

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What are “Catchup Contributions”?

Well, your normal allowable yearly contributions to 401k/403b and 457 are $18000 (as of 2017).

However, after the age of 50, this limit increases by $6000 to $24000 in order to help “catchup” in preparation for retirement. This also increases the prior maximum contribution of $54,000 (2017) from all sources to appropriately to $60,000.

You may have noticed that in all of my calculations, I don’t take this into account. This is on purpose.

This catchup contribution may change or be gone by the time we turn 50, and like other things, pensions, PLSF, etc, we shouldn’t count on it.

However, for completeness’s sake, I wanted to talk about here, with the example calculations.

Example:

You and your spouse are both 30 and starting your first jobs as attendings and begin contributing to your 401k plans. Luckily, your plans both have an employer match.

For simplicity, let’s assume you both put away up to the $18000 limit, which is $36000 for the both of you. Let’s assume the employer match is almost 100% at $34000, just to make the the round number of $70000. Also, remember that you are contributing to a Backdoor Roth IRA for each of you, at $11000 a year, but we’ll discuss that separately.

So then, $70000 a year for 20 years until you turn 50.

Then you turn 50 and can contribute the new maximum of $24000 each, or $48000 for both of you, with an employer match of $42000 (to make the math easy).

(Sensei’s note, depending on your employer 401k/403b they may not match catchup contributions in the same way. Check with yours.)

So now you’re putting away $90000 a year for the 10 years from 50 until 65.

Compound Interest Calculator helps us again here:

Input 1, $5833.33 ($70000/12 months), 20 years, 6% interest and you get:

$2,574,993.12

Now input 2574993.12, $7500 ($90000/12 months), 15 years, 6% interest and you get:

$8,265,958.15 and retire at 65

So by maximizing your catchup contributions, you put away $8.3 million dollars.

Now, this assumes you want to work for 35 years and retire at 65.

However, if you want to retire at 60, then input

2574993.12, $7500 ($90000/12 months), 10 years, 6% interest and you get:

$5,797,692.04

What if you didn’t utilize your catchup contributions?

Then just input, 1, $5833.33 ($70000/12 months), 35 years, 6% interest and you get:

$7,800,437.82 and retire at 65

or input, 1, $5833.33 ($70000/12 months), 30 years, 6% interest and you get:

$5,534,075.62 and retire at 60

Wait second… that’s not that different!

Well, let’s see:

If you wanted to retire at 60, it’s $5.8 million versus $5.5 million.

You put away an additional $20000/yr for 10 years ($200,000), and it resulted in an additional ~$300,000 at retirement.

However, only $12000 of that was your own money, so it’s really $120,000 resulted in an additional $300,000.

If you wanted to retire at 65, it’s $8.3 million versus $7.8 million.

You put away an additional $20000/yr for 15 years ($300,000), and it resulted in an additional ~$500,000 at retirement.

However, only $12000 of that was your own money, so it’s really $180,000 resulted in an additional $500,000.

That’s not a huge difference… why?

Compound Interest is powerful when you have years and years for it to work with consistent contributions. However, when it only has 10 years or so to work, the additional money you put in pales in comparison to the years and years of contributions and compound interest that you already have under your belt.

Catchup contributions were designed to help people put away more money who were unable to put away more money earlier for retirement.

Should I still do it?

If it’s available to us when we turn 50, then of course we should, especially if your employer will match your catchup contributions.

Free money is free money. Just don’t consider it to be the “savior” of your retirement, it’s not.

The point of this post is that increased limit from Catchup Contribution will not make a significant change in your overall plan if you’ve been saving from the beginning. You should not rely on it, and its compound interest is relatively weak in comparison to the prior 20 years contributions/compound interest.

I see… anything else I should know?

Yes.

For 403bs, there is a possibility of an additional contribution based on years worked:

Catch-ups for employees with 15-years of service

If permitted by the 403(b) plan, an employee who has at least 15 years of service with a public school system, hospital, home health service agency, health and welfare service agency, church, or convention or association of churches (or associated organization), has a 403(b) elective deferral limit that is increased by the lesser of:

1. $3,000,
2. $15,000, reduced by the amount of additional elective deferrals made in prior years because of this rule, or
3. $5,000 times the number of the employee’s years of service for the organization, minus the total elective deferrals made for earlier years.

from IRS.gov  (emphasis mine)

What if you have both?

If both catch-up provisions apply

While the age 50 catch-up is subject to an annual limit, the 15-year catch-up is subject to a use test, lifetime limit and an annual limit. When both catch-up opportunities are available, the law requires deferrals exceeding the standard limit ($18,000 in 2015 – 2017) to be first applied to the 15-year catch-up (to the extent permitted), and then to the age 50 catch-up.

from IRS.gov  (emphasis mine)

Can I do this for my Backdoor Roth IRA?

Yes, at age 50, you can put away $1000 more a year, $6500 instead of $5500.

For completeness’s sake:

If you started a Backdoor Roth IRA at age 30 with your spouse ($5500/yr each):

$11000 a year x 20 years then $13000 for 15 years, the calculation is:

Input 1, $917.67, 20 years, 6 % and you get:

$404,646.18

Then input 404646.18, $1083, 15 years, 6 % and you get:

$1,272,252.62

Approximately $1.3 million In post-tax dollars at 65, in addition to whatever you had in your 401k/403b.

TL;DR

Catchup Contributions are nice, allowing an additional $6000 to be away per year at age 50.

However, like pensions or PLSF, they shouldn’t be relied on.

Overall, this additional contribution pales in comparison to the prior 20 years of contributions/compound interest prior to 50.

But hey, free money is free money. Just don’t consider it to be the “savior” of your retirement, it’s not.

If you have a 403b, you may be able to put away more than the additional $6000 at 50.

For your Backdoor Roth IRA, there is also a catchup contribution of $1000 more (to $6500) at age 50.

-Sensei

Agree? Disagree? Questions, Comments and Suggestions are welcome.

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