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It's never too late for older workers to catch up on retirement savings

By Sandra Block, USA Today

August 26 2003

As much as we like to think of ourselves as masters of our fates, many things in life are out of our control. The weather. Crab grass. Drivers who won't use their turn signals.

And as the last three years have demonstrated, we can't control the stock market. Investors who thought they were on track for retirement watched helplessly as the bear market torched their portfolios and their dreams.

But there is one important aspect of retirement planning you can control: how much you save. And if you're age 50 or over, you have a golden opportunity to take charge of your portfolio.

The 2001 tax bill allows workers 50 and older to make catch-up contributions to 401(k)s or similar employer-sponsored savings plans. This year, older workers can contribute up to $14,000 to their retirement plan, vs. $12,000 for younger workers. By 2006, older workers will be able to contribute up to $20,000 of pretax income to their 401(k) plans.

Yet despite surveys showing Americans are more insecure than ever about retirement, the catch-up contributions haven't caught on. Part of the problem: Companies aren't required to offer catch-up contributions, and many were slow to revise their 401(k) plans.

But that excuse for not saving is rapidly disappearing. A recent survey by consulting firm Hewitt Associates found that about 90% of companies with 401(k) plans now allow older workers to make catch-up contributions. In addition, the IRS published final rules governing the contributions last month, which should encourage even more companies to amend their plans, retirement experts say.

The rules didn't contain any surprises, ''But they clarified a few uncertainties,'' says David Wray, president of the Profit Sharing/401(k) Council of America.

A kick in the pants

Companies may also start promoting the catch-up provisions to their older workers. But boosting participation won't be easy, says Nevin Adams, executive editor at Plansponsor.com. ''You have to max out on your current 401(k) contributions before you can make the catch-up, and most people aren't coming close to putting aside $12,000 a year in their 401(k) plans,'' he says.

Still, many workers in their 50s have more disposable income and are well-positioned to pump up their savings, Adams says. And even workers covered by federal ''non-discrimination'' rules can make catch-up contributions, he says.

The non-discrimination rules limit contributions by a company's higher-paid workers if lower-paid workers don't invest enough in the company plan.

The formula is designed to encourage companies to make their savings plans available to all workers, but it can also limit the ability of older workers to boost their retirement savings.

That's where the catch-up contributions are useful. Suppose, for example, you're 50 and the non-discrimination rule limits your contributions to $7,500 this year. By taking advantage of the catch-up contributions, you can save $9,500 in 2003, Wray says.

Roth vs. 401(k)

The 2001 tax bill also increased the amount older workers can contribute to a Roth IRA or traditional IRA. This year, workers 50 and older can contribute up to $3,500 to an IRA, vs. $3,000 for younger workers.

For most workers who meet income eligibility requirements, the Roth is a better deal. You don't get a tax deduction, but withdrawals are tax-free as long as you're at least 59 1/2 and have owned your Roth for five years.

Ideally, you should try to max out on your 401(k) plan and invest in a Roth. But many workers can't afford to put aside that much money, says Jonathan Guyton, a financial planner for Cornerstone Wealth Advisors in Minneapolis. In that case, some workers may be better off forgoing the catch-up contributions and putting money in a Roth instead, he says.

Here's why: Withdrawals from a 401(k) plan will be taxed at your ordinary income rate in retirement, while Roth withdrawals are tax-free. So if you expect your income tax bracket to stay the same or rise when you retire, you're better off with a Roth, Guyton says. If you expect your tax rate to fall, making pretax contributions to a 401(k) is a better deal, because you'll get the tax break when your tax rate is higher.

Of course, even the folks at the Psychic Hotline would have trouble predicting your tax bracket 15 years from now, particularly given the likelihood that lawmakers will continue fiddling with the tax code. Guyton offers this rule of thumb: If your tax bracket is 25% or lower, a Roth is a better deal, because your tax rate is likely to stay the same or increase when you retire. If your tax rate is 28% or higher, max out on your 401(k) plan first, he suggests, because there's a good chance your tax rate will be lower when you retire.