Take
Advantage of the New Pension Laws
By
Stephen J. Butler |
 Archives |
The surge of
new pension laws has widened the window of opportunity for retirement
savers. Anyone worried that a current nest egg will fall short
of what's needed for a secure retirement has been given a second
chance. If you are already fully invested for retirement, you
can put even more away for tomorrow while enjoying tax benefits
today.
Of course, just
because the laws have changed doesn't mean that your employer
will improve your opportunities. In fact, employers often hesitate
to change their retirement plans in the face of new legislation,
because change costs money and requires a communication effort.
Fortunately,
informed employees as a group have often been the agents of change
who drive retirement plan improvements. These 401(k) activists
have helped to create a better world not only for themselves but
for all future retirees.
In light of
the pension law changes, this column offers a simple but comprehensive
list of the key provisions. This is the list to keep in your wallet:
1. The 401(k)
voluntary contribution limit will be $11,000 in 2002 and will
rise by $1,000 per year until reaching $15,000 in 2006. The
limit is currently $10,500.
2. The maximum
401(k) contribution from all sources (i.e., employee voluntary
plus employer matching or profit-sharing contributions) is $35,000
in '01. It will increase to $40,000 in '02.
3. The maximum
earned income that can be considered for retirement plan contributions
- currently $175,000 -- will rise to $200,000 in '02. Previously
a company contribution equal to 10% of annual income would have
been maxed at $17,500; now it would be $20,000.
4. The dollar
limits above have often been superceded by percentage limits.
For instance, the maximum contribution for any
one employee
has been the
lesser of
$35,000 or 25% of income for 2001. For all employees combined,
the average percentage contribution from all sources could not
exceed 15%
of the entire payroll of eligible employees.
Under the new law, this 15% limit has been raised to 25% beginning
in '02.
5. The old
law would have included a voluntary 401(k) contribution as part
of the 25% limit. The new law separates out the voluntary 401(k)
contributions, allowing them to be over and above the 25% limit.
For all practical purposes, the former percentage limitations
are out the window. In most cases under the new laws, the dollar
limits
rather then the percentage limits will be the controlling factor.
6. "Catch-up"contributions
are an option for individuals aged 50 and over. This amounts
to an allowance of additional contributions over and above the
regular 401(k) voluntary dollar limits. The catch-up allowance
in '02 is $1,000. It will rise by $1,000 per year until reaching
$5,000 in '06. This means that by 2006, the total 401(k) voluntary
contribution will be $20,000 for anyone over age 50.
7. For lower-income
employees (those making less than $40,000 per year) there is
an increase of the percentage limit from 25% to 100% of income.
For employees earning over $40,000, the percentage limit of
100% is capped at $40,000. For these lower and middle-income
employees, the voluntary
401(k) deferral is included
in the maximum limits.
8. Retirement
plan participants who have been partners, sole proprietors,
or shareholders of a Subchapter S corporation have never been
allowed to borrow from their retirement plans. However, beginning
in '02, they will have the same borrowing privileges as all
other participants. The flexibility offered by the borrowing
provision (a contribution with a string attached) allows some
to make larger contributions than they could otherwise afford.
9. Defined
benefit plans that fund for a specific retirement benefit have
been vastly improved for those wanting to dramatically increase
a retirement nest egg in a short time. For owners of smaller
companies nearing retirement age, these plans now offer the
opportunity to contribute well in excess of $100,000 per year.
They are ideal tools for older owners or key managers of smaller
companies.
10. When it
comes to IRA's, today's $2,000 annual limit will steadily increase
to $3,000 for '02,'03 and '04. Then it will be $4,000 for '05,
'06 and '07. It will bump to $5,000 by '08.
11. "Bonus"
IRA contributions for people over 50 will be $500 in '02, '03,
'04 and '05. These contributions will bump to $1,000 in '06.
12. IRA contributions
will only be deductible for people who are not offered a retirement
plan by their employer OR whose incomes fall below $25,000 if
single and $40,000 if married.
13. Many of
these relaxed limitations also pertain to 403(b) plans (for
non-profit organizations), 457 plans (for government employees)
and so-called SIMPLE plans or SIMPLE 401(k)'s (offered by a
limited number of small companies.) There are differences among
these plans, however, so your employer should ask for a list
of changes comparable to the categories listed here.
What are the
bigger implications of this grab bag of changes? For one thing,
it now makes economic sense to take a second job or send a spouse
back to work. An extra $40,000 per year socked away in a retirement
plan earning 10% will accumulate to over $1,000,000 in just 13
years. That's one million dollars!
Furthermore,
the tax deductible treatment of the $40,000 means that it only
costs about $25,000-$30,000 of what would have been the additional
after-tax take-home pay. This giant "government subsidy"
could fill the hole left in our retirement plans by recent stock
market declines. It is the closest most of us will come to having
a numbered Swiss bank account.
Basically, the
new laws leave you with no excuse for not saving adequately for
retirement. All too often, the government has approached pension
legislation with a misguided mindset, but this time they have
done something right.
These new laws
allow us to save aggressively, and almost half of what we deposit
is money that would otherwise have disappeared in taxes. When
I first read these new provisions, I thought I was in some offshore
tax haven. Let's enjoy it while it lasts.
BUYandHOLD does
not offer or provide any investment advice or opinion regarding
the nature, potential, value, suitability or profitability of
any particular security, portfolio of securities, transaction
or investment strategy. Any investment decisions you make will
be based solely on your evaluation of your financial circumstances,
investment objectives, risk tolerance, and liquidity needs. The
securities mentioned above are being used for illustrative purposes
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of an offer to buy and past performance is no guarantee of future
results.
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