Retiree Portfolio Even More Money for Your Retirement

The president recently signed the Economic Growth and Tax Relief Reconciliation Act of 2001(EGTRRA) into law. Certain provisions in this act will allow increased participant contributions to tax-deferred retirement plans. Older workers will be allowed to make "catch-up" contributions to their plans. And transfers from one plan to another will now be allowed when we change jobs or leave the workforce. All in all, these changes allow greater opportunities for increased tax-deferred savings for retirement.

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By David Braze (TMF Pixy)
June 18, 2001

In a previous column, "More Money for Your Retirement," I wrote about a bill then pending in Congress that would change many aspects of the way people save for the golden years. The proposed bill has since passed both Congressional chambers in modified form (big surprise), and was signed into law by President Bush on June 7 as the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).

My colleague, Roy Lewis, has covered the major income and estate tax provisions of the EGTRRA in his June 2001 weekly tax columns. I will cover the major changes that affect our ability to save for retirement in this article.

The changes highlighted below will become effective on January 1, 2002 unless otherwise noted. Additionally, unless a future Congress and president enact new laws to say otherwise, these provisions will revert to pre-EGTRRA laws in 2011, due to a stipulation included in this act to ensure it complies with current budgetary limitations. While this "sunset" provision almost certainly will be revised before we reach 2011, Congress never ceases to amaze me with its smoke-and-mirror tactics.

Still, while it may seem ludicrous to believe a future Congress would allow these provisions to expire, when it comes to our illustrious leaders, I'm an enormous cynic. Anything may -- and often does -- happen in Congress. And given that our tax laws change on average every three years, I certainly won't guarantee that what pertains today will be what's allowed nine years from now.

With that caveat out of the way, here are what I believe to be the major retirement plan provisions of the new law:

IRA contributions
The maximum annual IRA contribution limit of $2,000 for traditional and Roth IRAs will increase to $3,000 in 2002 through 2004; $4,000 in 2005 through 2007; and $5,000 in 2008. Thereafter, the $5,000 maximum allowable contribution will be indexed to inflation in $500 increments. Those age 50 or older may increase these limits by $500 in 2002 through 2005, and by $1,000 in 2006 and thereafter. This "catch-up" limit of $1,000 will not be indexed for inflation.

401(k), 403(b), and 457 contributions
The maximum annual tax-deferred contribution ("elective deferrals" in technical jargon) to 401(k), 403(b), and 457 plans will increase from today's $10,500 ($8,500 for 457 plans) to $11,000 in 2002. The maximum will then increase in $1,000 annual increments starting in 2003 until it reaches $15,000 in 2006. When the new limit is reached, the maximum contribution will be indexed in $500 increments for inflation. Those aged 50 or older may increase these limits by $1,000 in 2002, and an additional $1,000 per year in each succeeding year until the increased contribution limit reaches $5,000 in 2006. After 2006, this $5,000 "catch-up" limit will be indexed to inflation in $500 increments.

Currently, employees may contribute up to the lower of 25% of annual compensation or $10,500 to their 401(k) or 403(b) plans. As of January 1, 2002, employees may contribute up to 100% of compensation subject to the maximum allowable annual dollar limit for the year concerned.

Currently, participants in state-provided 457 plans see their allowable maximum contribution reduced dollar for dollar when they also contribute to any other retirement plan provided by the state. Beginning next year, 457 plan contributions will no longer be reduced when elective deferrals are also made to other state-provided retirement plans.

As of January 1, 2002, the combined employee and employer contribution to a 401(k) or 403(b) plan will be the lower of $40,000 per year (as indexed) or 100% of compensation. Today's maximum combined contribution limit of 25% of compensation will no longer apply.

Starting in 2006, 401(k) and 403(b) plans may allow participants to make after-tax contributions to a Roth IRA-like account under separate plan-accounting procedures. These after-tax contributions and all earnings therein will not be taxed on withdrawal provided the account is open for at least five tax years and the participant is age 59 1/2 or older at the time of the distribution.

Asset transfer and vesting
Employees who change jobs will be able to roll over or transfer 401(k), 403(b), and governmental 457 plan assets from one type of plan to any of the others or to an IRA. Additionally, 401(k), 403(b), and governmental 457 plans may accept tax-deferred money transferred from traditional IRAs even when the transfer does not come from a conduit IRA. Further, unlike current law, after-tax contributions made to 401(k), 403(b), and governmental 457 plans may be transferred to a new plan or IRA.

The cliff vesting schedule (i.e., no vesting for a period of years with 100% vesting thereafter) for employer contributions to defined contribution plans will decline from the current legal maximum of five years to three years. The alternative 20% per annum graded vesting schedule will now begin in the second year of service, and will result in full vesting in six years. The changes to these vesting schedules mean employees will have 100% ownership of employer matching contributions much sooner than they do under current law.

SIMPLE changes
Limits for employee elective deferrals to SIMPLE plans will increase from the current annual maximum of $6,500 to a maximum of $7,000 in 2002. The maximum will then increase in $1,000 annual increments starting in 2003 until it reaches $10,000 in 2005. When the new limits are reached, the maximum contribution will be indexed in $500 increments for inflation. Those aged 50 or older may increase these limits by $500 in 2002, and an additional $500 per year in each succeeding year until the increased contribution limit reaches $2,500 in 2006. After 2006, this $2,500 "catch-up" limit will be indexed to inflation in $500 increments.

And there you have it. The EGTRRA provides all workers increased opportunities to save effectively for retirement. All that's required now is for us to take advantage of those provisions. I sincerely hope we do.

See you next week. Comments? As usual, post away on the Retirement Investing and/or the Retired Fools boards.

Best to all,
Pixy

Dave Braze rarely (try never) trusts Congress when it comes to legislation that affects anyone's pocketbook. This time, though, Dave thinks Congress (and the president) did the right thing. Therefore, because The Motley Fool is all about investors writing for investors, he thought you would be interested in knowing the major changes in law that will affect the way we save for retirement.