This is the second article in a series about how the new federal tax law can save you money. After launching the series with a look at investing for education, today we address how changes in the law affect retirement plans. Tomorrow's article will be on estate planning.
Taxes in 2002: Investing for Education
Taxes in 2002: Estate Planning
Like other instruments of unsung brilliance -- folding chairs, swimming goggles, tomato paste in tubes -- retirement plans dazzle few people at first encounter. But their value becomes increasingly apparent with the passage of time.
As part of our three-part series on taxes, today we focus on how changes to the federal law benefit people investing for retirement, with a primer on how two of the most popular investment plans work.
Starting this year, you can contribute more to your IRA.
In 2002, investors can put $3,000 in a Roth or traditional IRA, up from last year's max of $2,000. People age 50 and over can add $500 on top of that, for a total of $3,500.
By 2008, the IRA contribution limit increases to $5,000, to which people over 50 can add an extra $1,000.
Over time, those higher limits can make a huge difference in the size of your retirement account. Consider the following example from Vanguard: If you invested $2,000 a year for 20 years and had an 8% annual return, you'd end up with $100,000 in your account. But if you made a $5,000 annual contribution, at the end of the same period you'd have $250,000.
A few details are in order here: First, anyone can invest in a traditional IRA, but high-income taxpayers can't deduct it from their taxes. Eligibility for deductions depends on a given taxpayer's marital status and income, and whether he or she is covered by a retirement plan at work.
For example, if you're married, and both you and your spouse have access to retirement plans at work, your household income must be less than $54,000 in order for you to be eligible for a full deduction. You can receive a partial deduction if your income is between $54,000 and $64,000; people who earn more aren't eligible for the tax break.
Single taxpayers with work retirement plans must have income less than $34,000 for a full deduction, or between $34,000 and $44,000 for a partial deduction. Above $44,000,
At age 59 1/2, you can start taking money out of a traditional IRA without penalty, though you'll still have to pay income tax. Before that age, withdrawals are subject to a 10% federal penalty and a state tax penalty, on top of income taxes (unless you've run into serious financial hardships, in which case you may be able to duck the penalties).
Eventually, you have to start taking out money and paying income taxes on a traditional IRA; the government requires you to start withdrawing from your account by the year after you turn 70 1/2. Since the feds let you deduct the amount contributed to the traditional IRA, you have to pony up with taxes when you're older.
In a sense, Roth IRAs work the opposite way from traditional IRAs. With Roth IRAs you pay income taxes on the amount you contribute, but you don't have to pay tax on the money you later withdraw. That's a sweet benefit: By the time you take out your money, it has presumably had years to appreciate in value.
Also, because you already paid taxes on the money, the government doesn't care when you withdraw it. In fact, you're free to never withdraw it at all and simply bequeath a Roth IRA to your heirs.
But Roth IRAs aren't an option for people with high income. To make a full contribution to a Roth IRA, a married taxpayer must have household income less than $150,000, or between $150,000 and $160,000 for a partial contribution. If household income is above the latter limit, you can't open a Roth.
Single taxpayers must have income below $95,000 to be allowed to make a full contribution, or between $95,000 and $110,000 to make partial contributions.
In 2002 you can invest more in your 401(k) or 403(b) retirement plan.
The annual contribution limit rose from $10,500 to $11,000 for this year. Plus, people aged 50 and up are allowed to invest an extra $1,000, for a total investment of up to $12,000.
By 2006, annual contributions will jump to $15,000, with people over 50 allowed to throw in an additional $5,000, for a total of $20,000.
That wraps up the new guidelines for retirement planning. Tomorrow, we'll report on changes in estate taxes and explain why they're causing so much confusion.
In the meantime, if you want to seek out more tax info on your own (or if you are just profoundly, soul-suckingly bored), pore over new regulations to your heart's content at the IRS'
epic online guide.