Are Catch Up 401k Contributions Pre-Taxed for Over 50?

The intent of Congress when it created catch-up contributions was to allow employees who are getting closer to retirement to contribute extra money to their retirement accounts. In that way, they could “catch up” for years in which they made small or no contributions.

401(k) Catch-Up Contribution

To make a 401(k) catch-up contribution, you must be a “catch-up eligible participant,” meaning you satisfy all of these criteria:

• You must be a participant in a 401(k) plan.
  
• You must reach at least age 50 in the year of the catch-up contribution. Fifty is called the 401(k) catch-up age.
  
• You are eligible to make elective deferrals to the 401(k) plan.
  
• You have made the maximum elective deferrals up to a defined limit, which can be a statutory, plan-imposed or applicable limit.    

Limits on 401(k) Contributions

In a traditional 401(k), participants make contributions through pretax elective deferrals. In most cases, participants can defer up to 100 percent of their taxable income or the statutory limit, whichever is less. The statutory limits (the legal limitation on the amount of elective deferral) for 2018 and 2019 are $18,500 and $19,000, respectively. The statutory limit on the total combined employee/employer additions (excluding catch-up contributions) to a 401(k) plan in 2018 is $55,000 and $56,000 in 2019. The 401(k) catch-up limit for 2018 and 2019 is the lesser of $6,000 or 100 percent of your compensation minus elective deferrals. Therefore, the maximum employee pretax contribution amounts (elective deferral plus catch-up contribution) for 2018 and 2019 are $24,500 and $25,000, respectively.

Some plans impose different elective deferral limits such as a fixed percentage of a participant’s compensation. The limits on plans that are subject to actual deferral percentage (ADP) testing – a test to ensure that the ratio of deferrals for highly and non-highly compensated employees don't exceed certain limits – are known as applicable limits and are equal to the elective deferral limits on highly compensated employees. Whatever the method for determining maximum elective deferrals, an employee must first reach that limit before taking advantage of catch-up contributions. Some 401(k) plans do not permit catch-up contributions.

Catch-Up Contribution Tax Savings

Withdrawals from a traditional 401(k) are ordinary income, taxed at your marginal rate. As of 2018, the federal income tax has seven rates, ranging from 10 to 37 percent. If you are in the 22-percent tax bracket and make a $6,000 catch-up contribution, you save $1,320 (0.22 x $6,000) in taxes. Top-earning taxpayers in the 37-percent bracket save $2,220, and for those paying the 3.8-percent Medicare surtax on modified adjusted gross income exceeding the annual limit, there is an additional savings of $228.

Roth 401(k) Catch-Up Contributions

Your employer might offer you a separate Roth account within your 401(k) plan in addition to the traditional account. The limits on elective deferrals and catch-up contributions are the same as for traditional 401(k)s. The difference is that contributions are made with post-tax dollars. That is, Roth contributions have already been taxed, and you cannot deduct these contributions from your taxable income for the year. Distributions of Roth contributions are always tax-free. Distributions of Roth account earnings are tax-free unless you are under age 59 1/2 or the first contribution occurred less than five years ago. Early withdrawals of earnings might also be subject to a 10 percent penalty tax unless they qualify for an exception. The total annual amount that can be added to your 401(k) plan is the same with or without a Roth option.

Required Minimum Distributions

If you are familiar with the required minimum distribution (RMD) rules for IRAs, you might be surprised to learn that 401(k)s dance to a slightly different drummer. The two account types have in common the amount of each year’s RMD, which is based on your age, your life expectancy as estimated by the IRS and the account balance. With a traditional IRA, you must start taking RMDs in the year following your 70 1/2 birthday and can no longer make any contributions. However, if you are in a 401(k) and are still employed beyond age 70 1/2, you can postpone your RMDs and continue to make tax-deferred contributions including catch-up contributions. However, these postponement rules aren’t available if you own 5 percent or more of the company sponsoring the 401(k), as would be the case with a one-participant (or Solo) 401(k).

The RMD rules are the same for Roth and traditional 401(k)s. Roth 401(k)s differ from Roth IRAs in that the latter have no RMDs.

401(k) Employer Contributions

In addition to employee elective deferrals, many 401(k) plans permit employers to add to your account through any combination of nonelective contributions, matching contributions based on the employee’s elective deferrals, and allocation of nonvested money from the 401(k) plans of participants who leave the company. Employers cannot contribute more than 100 percent of the employee’s salary.

As an example, in 2019, Joe can defer $19,000 of his income and also make a $6,000 catch-up contribution. The overall contribution limit (that is, employer plus employee contributions, not counting catch-up contributions) is $56,000, meaning that Joe’s employer can kick in up to ($56,000 minus $19,000), or $37,000 in employer contributions. Notice how catch-up contributions do not figure into the employer’s contribution limit. The 401(k) plan can specify whether an employer will match an employee’s catch up contributions, but in either case, the same employer contribution limits apply.

401(k) Post-Tax Contributions

Many people assume that post-tax contributions to a 401(k) can be made only to a Roth account. However, some plans instead allow after-tax contributions to a traditional 401(k) account. These contributions can exceed the limit on employee elective deferrals but must conform to the overall limit on all contributions.

For example, assume Joe’s employer makes a nonelective contribution of $11,000. Since Joe deferred $19,000, his overall pre-tax addition for 2019 is $30,000, not counting his $6,000 catch-up contribution. The annual overall limit is $56,000, which means that Joe can contribute up to $26,000 (that is, $56,000 minus $30,000) of post-tax money to his traditional 401(k) account, but only after maxing out his catch-up contributions.

This post-tax contribution adds to the cost basis of the 401(k) account. When contributions are distributed from the 401(k), the amount up to the cost basis is tax-free, and the cost basis is reduced by the distributed amount. The earnings on post-tax contributions don’t increase the cost basis, so they are taxable when distributed once the cost basis has been depleted. To avoid taxation on earnings stemming from post-tax contributions, you can roll your post-tax contributions into a Roth IRA, where you can withdraw earnings tax-free as long as you observe the rules. The other benefit of this rollover is that it isn’t subject to the IRA annual contribution limit and, therefore, allows you to pour additional cash into your Roth IRA.