By Marcia Mantell, RMA
On June 7, 2001, then President George W. Bush signed one of the most influential tax cuts and retirement savings bills into law. The Economic Growth and Tax Relief Reconciliation Act of 2001—known as EGTRRA (egg-tra)—squarely recognized a shift that was well underway. Namely, that the baby boomers and younger generations were going to be fully responsible for funding their own retirements.
And, they were facing an uphill battle as longer life expectancies became a reality.
Workers needed more opportunities to save more for retirement. And, coming out of the 2000-2001 recession drove the point home. It was time to expand tax-advantaged retirement savings especially for older workers who were much closer to retirement.
EGTRRA Provisions - An Overview
While the splashy headlines touted the tax cuts and repeal of the estate tax as the major provisions, EGTRRA offered sweeping changes on many fronts. Tax reductions and opportunities for tax deductions came in many different forms. Overall, this law afforded workers and retirees with the following:
· Reduced tax rates from 39.6% to 35%, 36% to 33%, 31% to 28%, and 28% to 25%; plus, a new 10% rate
· Phased-out estate and generation-skipping transfer taxes to 0% in 2010
· Eliminated the phase-down of itemized deductions for those earning over $100,000
· Increased tax deductions for education expenses and savings
· Doubled the child tax credit to $1,000
· Made the Earned Income Tax Credit more generous
· Provided relief from the Alternative Minimum Tax
In addition, EGTRRA ushered in two powerful changes for retirement savers:
· it increased tax-deductible contributions to IRAs, 401(k)s, 403(b)s, and small business retirement accounts; and
· introduced the catch-up provisions for those who were 50 and older
Increased tax-advantaged savings allowed in employer plans
Taking a look back at the contribution limits on both 401(k)/403(b) plans and on IRAs, we see decades of lost savings opportunities. Contribution limits were severely cut in 1986 on the new 401(k) plans—from $30,000 annual contributions to only $7,000 as the result of tax revenue needed at that time. The limit only incrementally increased over the next 16 years.
EGTRRA’s new rules increased savings contribution limits by $1,000 per year from 2002 to 2005, reaching, $15,000, then increases will be indexed for inflation.
In addition, the total contribution cap allowed between individual and employer contributions broke free from the $30,000 limit in place since 1982. Increases are typically annual, rising in $1,000 increments tied to inflation. This year the total combined limit is $58,000.
IRA contribution limits—static for two decades
We tend to focus on employer plans as a way to save effectively for retirement. But, only about 50% of all U.S. workers have access to these plans. That makes the IRA incredibly important for the millions of workers without tax-advantaged savings opportunities at work.
When first introduced in 1974, the IRA limit was $1,500 for those with earned income. Eight years later, in 1982, the limit increased to $2,000, and stayed locked in for the next 20 years.
EGTRRA increased IRA contribution limits beginning in 2002, setting the annual limit at $3,000, rising to $5,000 in 2008. After that, increases were tied to inflation. That’s why today’s contribution limit sits at $6,000.
Catch-up contributions designed to help those closest to retirement
Allowing older workers to save more is an interesting concept. The 107th Congress recognized the pending problem for those closest to retirement. They didn’t have sufficient opportunities to save in tax-advantaged accounts for the 30 years they would spend in retirement.
That prior 20-year period with little to no savings increases put an entire generation of retirees at a disadvantage.
And so, catch-up provisions were introduced. For those who reached age 50 (or older) starting in 2002, they could contribute $500 more to an IRA and $1,000 more in a 401(k) or 403(b). Furthermore, the 401(k) catch-up would increase by $1,000 each year up to $5,000, then rise with inflation.
This was a remarkably creative way to address the significantly underfunded retirements of tens of millions of Americans. And, with a 15-year window to save more, many baby boomers would have the opportunity to shore up their personal finances.
Now, 20 years after EGTRRA was signed into law, has the catch-up provision done what it was intended to do?
The catch-up provision has not exactly caught on
Since the recession of 2008, the average 401(k) account balance has certainly been on the rise. Those who are older, have even higher balances. That bodes well for more secure retirement funding.
But the catch-up provision does not seem to be playing as large a part in the savings strategy. There is little comprehensive data on catch-up contributions but by most industry and recordkeeper reporting, few participants make contributions to their plans, and even fewer to IRAs.
And, not surprising, the higher income workers and those with substantially higher balances in their plan accounts are the ones making catch-up contributions.
To make the EGTRRA provisions work for you, it is important to use both the increased contribution limits and the catch-up provisions to your best advantage. Securing your own retirement income is a top priority. And, every little bit of extra contribution to your IRAs and employer plans does make a difference.
The value of catch-up contributions
Anyone who turned 50 back in 2002 and started using catch-up contributions made a significant difference their retirement pot of gold. Let’s assume those first eligible for the 401(k) catch-up retired in 2018 at age 66. Looking at just their catch-up money, they would have an extra $134,000 saved for retirement (assumes maximum catch-up contributions from 2002 – 2005, then $5,000 in annual catch-up contributions from 2006 – 2018. Average rate of return is 7%.).
Now, consider they won’t need to tap that money in year one of retirement. In fact, with a 30-year retirement outlook, they can continue to keep this money invested for say another 15 years. If they garner an average 5.5% return, their catch-up money becomes a whopping $305,000. That is a nice portfolio to start the back half of their retirement years.
But let’s be serious…who really has $5,000 to take out of cash flow every year from the time they are 50 until retirement? There’s no rule that says you have to contribute the maximum. Just making smaller catch-up contributions still makes a positive impact on your retirement savings.
Can you find $100 per month to save from 50 to 67? At a 7% average return, you’ll have almost $44,000 additional dollars for retirement. Leave it invested for the next 15 years at 5.5%, and you’ll celebrate your 82nd birthday with an extra $100,000.
If you can stash away $200 per month from 50 to 67 (using the same assumptions), your 82nd birthday comes with nearly $200,000.
Take advantage of the EGTRRA provisions
The importance of the vastly improved savings limits ushered in under EGTRRA really should be celebrated. Every baby boomer, Gen Xer, and even the millennials have a lot more opportunity to save for their retirement thanks to EGTRRA.
Here are a few ways to continue to find more money to save and invest for your golden years:
1 – Take advantage of the higher limits in your employer plan if you have one. Increase your contributions 1% per year up to the maximums.
2 – Start an IRA if you don’t have one already. Move $50 a month via autopay to get that account started.
3 – Once you reach age 50, jump into the catch-up contributions in your employer plan and IRA. Take proactive steps to increase your contributions for catch-ups.
4 – The year you turn 55 you can also add more to your health savings account. An extra $1,000 can be directed to your HSA as catch-up dollars.
5 – Think about your catch-up dollars as retirement income in your 80s. Start saving at 50, continue investing until your 80s.
Here’s to the retirement improvements brought to you by EGTRRA. Make sure you take full advantage to help build and protect your income and lifestyle throughout retirement.
About the author: Marcia Mantell, RMA®, NSSA®
Marcia Mantell is the founder and president of Mantell Retirement Consulting, Inc., a retirement business consultancy. She develops innovative programs, marketing materials, and educational workshops for the financial services industry, advisors, and their clients. She is author of “What’s the Deal with Retirement Planning for Women?”, “What’s the Deal with Social Security for Women?” and blogs at BoomerRetirementBriefs.com.
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