If you're worried about how well your retirement savings are keeping up, there's some good news. With the new tax bill signed into law earlier this month, you've got more opportunities than ever to accumulate tax-sheltered retirement wealth.
In fact, the new tax bill beefs up most of the key tools you can use to build a financially secure retirement. Other changes could swell your retirement account without you having to set aside a nickel more.
Here's an overview of the major changes and some advice on how to take the most advantage of them.
Traditional and Roth IRAs:
The maximum annual contribution to a traditional or Roth IRA will rise from $2,000 to $3,000 for 2002 through 2004, $4,000 for 2005 through 2006, and $5,000 for 2008 and later years. And if you're age 50 or older, you can make an extra $500 contribution for 2002 through 2005 and an extra $1,000 for 2006 and later years. Contributions to a traditional IRA are deductible if you (and your spouse, if you're married) don't actively participate in an employer-sponsored retirement plan, but the deduction phases out at relatively low levels of adjusted gross income (AGI) for active participants. However, the IRA deduction phaseout for a
participant spouse (such as a stay-at-home Mom or Dad) married to an active participant begins at a relatively high $150,000 of AGI.
Liberalized 401(k) limits:
The current $10,500 maximum annual elective deferral to a 401(k) plan will rise to $11,000 in 2001, and increase by an additional $1,000 for each subsequent year until the limit hits $15,000 in 2006. And employees age 50 or older will be able to make additional "catch-up" contributions of $1,000 for 2002, increasing by $1,000 for each subsequent year until the catch-up limit is $5,000 for 2006 and later years.
What's more, the catch-up contribution isn't subject to any other contribution limits, either. So if, for example, a given 401(k) plan lets a 51-year-old employee defer a maximum of 8% of her $80,000 salary, she'll be able to put away $7,400 next year ($6,400 regular contribution plus $1,000 catch-up). The more generous contribution and catch-up limits also will apply to 403(b) tax-sheltered annuities, Sec. 457 plans run by state or local governments and salary-reduction simplified employee pension (SEP) plans.
Where to put extra cash?
If you're already putting enough into your 401(k) to get the maximum employer match, you may be wondering whether you should put additional savings into the 401(k) plan or set aside the extra cash in a Roth IRA, now that the contribution limits for both have been raised.
The answer is, if you think you'll be in the same tax bracket when you need to make withdrawals that you're in now, and you've got a long way to go before you retire, then the Roth IRA probably is the way to go. The contribution isn't deductible, but earnings within the account accumulate tax-deferred, just as in a 401(k) plan. And if you hold the Roth IRA for at least five years and make withdrawals after one of several events, such as attaining age 59 1/2, the earnings will be paid out tax-free.
However, if you're in a high tax bracket now and anticipate being in a lower one when you retire, put the extra cash in the 401(k) plan up to the elective deferral limit. This way, you'll be investing pretax dollars, your earnings will be tax-deferred and payouts will (hopefully) be taxed at a lower bracket.
If you're already making the maximum pretax elective deferral to a 401(k), then put the extra cash in a Roth IRA instead of setting aside additional after-tax dollars in a 401(k), where you'll have to pay taxes on the earnings when you withdraw the money. Keep in mind, however, that the annual Roth IRA contribution limit phases out over AGI ranges that vary with filing status (e.g., $150,000-$160,000 for joint filers, $95,000-$110,000 for singles).
Beginning in 2006, the AGI limits won't be a problem if your company plan offers the option to treat elective deferrals as Roth contributions (not all companies will, though, because there are bound to be administrative costs associated with this change). At that time, you'll be able to make Roth contributions within the plan up to the elective deferral limit ($15K in 2006) regardless of your AGI.
More generous vesting rules for matching contributions:
The new law makes it possible for some job hoppers to take more retirement dollars with them when they change plans. Currently, an employee becomes 100% vested in an employer's matching contributions to a 401(k) plan after either five years of service, or seven years of service at a rate of 20% a year beginning with the third year. Starting in 2002, though, you'll be 100% vested in matching contributions after just three years of service, or, alternatively, after six years at 20% a year beginning with the second year.
There are also other breaks for frequent job hoppers in the new tax bill. For example, beginning next year, you'll be able to roll over after-tax contributions from one plan to another, or to an IRA (currently, you can't roll over after-tax contributions between plans and you can't roll over IRA cash into a qualified plan). Additionally, rollovers will be allowed between different types of plans. For example, you'll be able to roll over a profit-sharing payout into a 457 governmental plan, or vice versa.
If you've got your own business:
Beginning next year, business owners will be able to set aside more money for their retirement than ever before, regardless of the type of plan they use. For example, with a "defined contribution" (profit-sharing or stock bonus) plan, your company will be able to put away 100% your of compensation up to $45,000 each year (instead of today's 25% of pay up to $35,000) for you. And your maximum annual deductible contribution will be 25% (up from 15%) of compensation. What's more, employee elective deferrals to 401(k) plans won't count toward the 25% deduction limit, and won't be included in the compensation base used to figure the deductible contribution limit.
If you use a SIMPLE plan, used for businesses with fewer than 100 employees, your maximum annual contribution will rise, too. The current $6,500 limit goes to $7,000 for 2002, $8,000 for 2003, $9,000 for 2004, and $10,000 for 2005. And if you're 50 or older, you can make extra catch-up contributions as well ($500 more in 2002, $1,000 in 2003, $1,500 in 2004, $2000 in 2005, and $2,500 in 2006).
The ball's in your court:
There are more opportunities to accumulate retirement wealth than ever before, but you've got to have the discipline to put extra cash away in tax-favored retirement savings accounts, and leave it there until you retire.
Bob Trinz is a tax specialist and manager of news and alerts at RIA, a provider of information and technology to tax professionals.