A catch-up contribution is an excess contribution made to a retirement plan with the goal of ensuring that enough money will be available for retirement. Retirement plans qualify for certain tax benefits if they are administered in accordance with regulations and these regulations also provide some room for catch-up contributions. In regions where such contributions are allowed, for tax purposes they are treated like regular contributions, providing an incentive for people to put more money aside.
Usually, in order to be allowed to make catch-up contributions, people need to belong to savings plans that allow such contributions. Most do, but it is advisable to consult an employer to confirm that that the plan will allow them. People must also generally be over age 50, as the catch-up contribution is intended for people who are close to retirement and concerned that they will not have enough funds available in their retirement accounts.
If someone has exceeded the limit on regular contributions for a given year, that person is allowed to make a catch-up contribution up to a certain amount. This is done by taking an elective deferral on money earned, with the employer depositing some of the money earned each month into the retirement account instead of providing it in the form of pay. The employee does not pay taxes on the money deposited in the retirement account.
The basic limits, as well as catch-up contribution limits are periodically adjusted to reflect the cost of living. This is commonly done in October, using information from the previous two financial quarters to judge inflation. The adjusted rates are made publicly available so that people know how much money they will be allowed to submit into tax-deferred savings plans each year. Accounts and benefits administrators can offer counseling to employees about the plans available, how much money they can contribute, and other information that might be valuable to have for retirement planning.
As with other deposits into a savings plan, a catch-up contribution is taxed when it is withdrawn, rather than when it is deposited. When people start drawing on their savings accounts to support themselves in retirement, they will have to pay taxes each year on the monies paid out. It is advisable to work with an accountant ahead of time to make plans for retirement and to learn about how to manage retirement funds effectively. There are some tips that can help people reduce tax liability while in retirement that an accountant can provide, and a tax specialist can offer additional advice on structuring and using retirement accounts.