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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 The dollar limits above have often been superceded by percentage limits.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 only and should not be regarded as an offer to sell or as a solicitation of an offer to buy and past performance is no guarantee of future results.



 

 

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