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Retirement and Taxes

By Roy Lewis

One of the major changes to the tax law under the Economic Growth and Tax Relief Reconciliation Act of 2001 has to do with retirement plans and other deferred-savings plans. Make no mistake -- these changes are substantial (though not as great as some would have liked). But there are many planning and tax-saving opportunities built into the new laws. Let's take a look at some of the major provisions.

IRA contribution limits
The contribution limits for both traditional and Roth IRAs will increase from the current $2,000 annual limit to $5,000. This increase will be phased in over several years. Here's how the contribution limits will look:

  • 2002 through 2004: $3,000 max contributions
  • 2005 through 2007: $4,000 max contributions
  • 2008: $5,000 max contribution

After 2008, the maximum contribution amount will be adjusted for inflation. What does this mean to you? It means that in 2002 your maximum IRA contribution limit will increase by 50% over the currently allowable $2,000. And in 2008, when the full increases are in place, your maximum IRA contribution limit will have increased a whopping 150% over the current $2,000 limit. Before you blanch at the size of these increases, remember that maximum IRA contribution limitations haven't increased for more than 20 years. So much of this increase is nothing more than catching up for Congressional inactivity.

IRA catch-up contributions
Those of you who are age 50 and above will be permitted to make additional contributions to your IRAs. How much and when? Check this out:

  • 2002 through 2005: $500
  • 2006 and thereafter: $1,000

Remember that the catch-up provisions apply to regular IRAs and Roth IRAs, but the AGI limits for deductibility of traditional IRA contributions and eligibility for Roth IRA contributions are still in play. You can also mix and match your regular contributions and your catch-up contributions as you see fit... some to your traditional IRA and some to your Roth IRA. If you're eligible for the catch-up provisions, this means that you can make a $5,000 contribution to your IRA in 2006. And by 2008, your maximum contribution will increase to $6,000. If you were delinquent in making IRA contributions early in your earning life, these catch-up provisions can help to ease the pain by permitting you to save more in tax-deferred and/or tax-free accounts.

Deferred compensation contribution limits
These will also increase over time. These increases will apply to 401(k), 403(b), 457 plans, and Salary Reduction SEP (SARSEP) Plans. The maximum contribution limits will be increased as follows:

  • 2002: $11,000
  • 2003: $12,000
  • 2004: $13,000
  • 2005: $14,000
  • 2006: $15,000

After 2006, the maximum contributions will be indexed for inflation. And there are also catch-up provisions for these types of plans. Beginning in 2002, for workers age 50 and older, the catch-up amount that can be contributed will amount to $1,000, and will increase by $1,000 each year until 2006 (resulting in a $5,000 catch-up). After that, the catch-up amount will be indexed for inflation. And these catch-up provisions are in play even if your contributions would otherwise be limited, even if the limitation is caused by non-discrimination provisions or a limit based on your percentage of compensation. So in 2006, if you're age 50 or older at that time, your maximum contribution to your 401(k) or similar plan could be as much as $20,000 -- $15,000 in regular contributions and $5,000 in catch-up contributions.

SIMPLE plan contributions
SIMPLE plan limitations were also increased, along with catch-up provisions. They look like this:

Simple LimitsCatch-Up Limits
2002       $7,000               $500
2003       $8,000             $1,000
2004       $9,000             $1,500
2005      $10,000             $2,000
2006      Indexed             $2,500
Future    Indexed            Indexed

Contribution tax credit
Beginning in 2002, lower-income taxpayers will receive an additional credit (up to 50% of the contribution) for virtually any contribution made to a retirement account, including 401(k) plans, 403(b) plans, and IRAs (both traditional and Roth). While this is a wonderful idea in theory, the income limits are set so low that most of the people targeted with this credit likely won't have enough discretionary income to save for retirement. Another problem is that many of the lower-income taxpayers might not have a tax liability anyway. So this credit might be more sizzle than steak. For the time being, just know that this provision is out there, but won't kick in until 2002.

Employer plan benefits
If you're an employer, you'll be pleased to know that you'll be able to offer even more generous retirement benefits to your employees (and to yourself, of course). Why? Because beginning in 2002:

  • The current $35,000 limit for defined-contribut