New US Tax Law Benefits Savers

by Mike Godfrey, Tax-News.com, New York

27 November 2001

Few Americans are aware of the multiplicity of savings improvements included in the Economic Growth and Tax Relief Reconciliation Act of 2001.

One of the chief advantages of the new tax law is that it allows for big increases in contributions to individual retirement accounts and 401(k)s. Currently, individuals can put a maximum of $2,000 a year into an IRA. That limit will increase to $3,000 annually for 2002 to 2004, and then rise to $4,000 for the years 2005 to 2007, before reaching $5,000 in 2008.

Starting next year, workers participating in 401(k) plans will be allowed to set aside from their salaries up to $11,000 tax-deferred each year, up from the current limit of $10,500. In addition, the deferral limit will increase $1,000 a year through 2006. That means the deferral limit will rise to $12,000 for 2003, $13,000 for 2004, $14,000 for 2005 and $15,000 for 2006. After 2006, all future increases to the deferral limit will be tied to cost-of-living increases and made in $500 increments.

One of the most talked-about features of the new tax law allows 401(k) plan participants age 50 and older to make annual "catch-up" contributions, which allow people to make up some ground if they have procrastinated or been financially unable to set aside money. So beginning in 2002, these people can make - above and beyond the limits noted above - contributions of up to $1,000 in 2002, $2,000 in 2003, $3,000 in 2004, $4,000 in 2005 and $5,000 in 2006. After that, future increases in the catch-up amounts will be tied to cost-of-living increases and made in $500 increments.

In addition, government employees will be able to move funds among a variety of tax-deferred retirement-savings vehicles, including 403(b) plans, some 457 plans and traditional IRAs. This is an option not currently available. The new law also allows people in nonprofit or government jobs to carry the money in those plans to a 401(k) if they switch to the private sector, or vice versa. The new law will allow those working for nonprofit groups or the government to put in their retirement accounts the same amount as those in a 401(k) plan. In 2002, both sets of workers will be able to contribute $11,000.

The new law also accelerates vesting options, allowing employees - especially those who plan to change jobs - to more quickly grab employer contributions. Currently, employees must wait at least five years to leave a company to avoid forfeiting the portion of 401(k) contributions provided by the employer. But under the amended tax law, the schedule is lowered to three years. And the seven-year graded schedule, where vesting occurs in increments over seven years, is replaced by a six-year graded schedule. The new law doesn't change vesting requirements for other employer contributions made to a 401(k) plan, such as profit-sharing contributions, that aren't considered matching contributions.

Starting in 2002, owner-employees, such as partners, sole proprietors, and certain S corporation shareholders, may obtain loans from 401(k) plans just like other participants. Small companies that want to establish pension plans will benefit from a change that allows a credit for 50% of qualified plan start-up costs. The credit is limited to $500 for each of the first three years only. The employer cannot have more than 100 employees who received more than $5,000 in compensation, and the plan must have at least one participant.

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