It's a story that's all too familiar to many: You spent most of your money in your younger days on buying a home, raising children, and saving for their college educations. Now you're over 50 and you realize you're nowhere near ready for retirement. Fortunately, you can make up for lost time by making 401(k) catch-up contributions. Below, we'll look at what these are and what difference they can make to your retirement savings.

How 401(k) catch-up contributions work

Catch-up contributions are extra retirement account contributions that those 50 and older can make each year. In 2020 and 2021, adults under 50 may contribute up to $19,500 per year to their 401(k)s. Adults 50 and older may add an extra $6,500 to this limit, bringing their total contribution limit for 2020 and 2021 to $26,000 per year.

A stopwatch on top of a fanned stack of one-dollar bills.

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You don't have to do anything special to make catch-up contributions. If you already have money taken out of each paycheck, you're good to go. But you may need to raise the percentage you're deferring to your 401(k) if you plan to take advantage of them.

Catch-up contributions are taxed in the same way as normal 401(k) contributions. This usually means that your contributions reduce your taxable income for the year, and you pay taxes on your withdrawals later. But if you're using a Roth 401(k), you pay taxes on your contributions now in exchange for tax-free withdrawals later.

A few thousand dollars more per year may not seem like that much when retirement can cost well over $1 million, but you may be surprised at how much of a difference catch-up contributions can make over the long term.

A catch-up contribution example

Ideally, you'll have some retirement savings by the time you're in your 50s; however, for the purposes of this example, let's say you don't have any money saved at all. 

If you're 50 years old and you plan to retire at 67, that gives you 17 years to save what you need. If you contributed the under-50 maximum of $19,500 per year over that time and you earned a 7% average annual rate of return, that would give you a little over $601,000. And you could end up with even more than this if your employer matched some of your contributions.

But what if you decided to contribute the maximum $26,000 every year instead? With the same average annual rate of return, you'd end up with over $801,000. Again, this is even before considering the benefit of an employer match. That's a difference of about $200,000, and only $110,500 of that is additional personal contributions. The rest comes from investment earnings.

Is that enough for you to comfortably retire on? No one can say for sure. How much you need to retire depends on how long you expect your retirement to last and what you think your lifestyle will be like. But it's clear that catch-up contributions can make a significant difference in your retirement savings, especially if you start making them as soon as you're eligible.

What if my catch-up contributions aren't enough?

If you don't think you can save as much as you need even with 401(k) catch-up contributions, you have a few options. If you have some extra cash to spare, you can open up an IRA. These have catch-up contributions as well: Adults 50 and older may contribute up to $7,000 each in 2020 and 2021 -- that's $1,000 more than adults under 50 can contribute.

You could also try investing money in a taxable brokerage account. These don't offer the same tax breaks as retirement accounts, but if you hold your savings for longer than one year, they become subject to long-term capital gains tax. This can grant you more preferable tax rates on your earnings than if you pay standard income taxes.

If you don't have extra cash to put toward retirement, you could always try delaying retirement instead. This gives you additional time to save while also reducing the length of your retirement, so you can afford to retire on less. You'll have to do the math to figure out how much longer you'd need to work, but even a few months can make a big difference.

Keep in mind that 401(k) contribution limits can change over time, so while you're allowed to make only $6,500 in catch-up contributions for 2020 and 2021, you may be allowed to contribute even more in future years. Check these limits every year to make sure you're not missing out on an opportunity to save even more.