Suze Orman, Financial Guru
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Retirement Tax and Saving Incentives

With the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001, many tax laws that affect you have been changed. The increases the limits on contributions to qualified retirement plans is especially important at a time when people are living longer and assuming more responsibility for their retirement income. One of the biggest changes has to do with the increased maximum contributions people can make to their retirement accounts. These maximum contributions are affected by how old you are. Significant changes are as follows:

The maximum amount that could be contributed to a traditional IRA account and a Roth IRA account which had been set at $2,000 for the last 20 years is increased according to the following schedule: 

Year Under 50 Age 50 and Above
  Annual Contribution Limit Annual Contribution Limit
2002
2003
2004
2005
2006
2007
2008
$3,000
$3,000
$3,000
$4,000
$4,000
$4,000
$5,000
$3,500
$3,500
$3,500
$4,500
$5,000
$5,000
$6,000

 

After 2008 increases adjusted for inflation in $500 increments.

Increase the limits on employee contributions to 401(k) and 403(b) plans.

Year Under 50 Age 50 and Above
  Maximum Deferral Limit Maximum Deferral Limit
2002
2003
2004
2005
2006
$11,000
$12,000
$13,000
$14,000
$15,000
$12,000
$14,000
$16,000
$18,000
$20,000

Increases the limits on contributions to SIMPLE plans (maintained by employers with fewer than 100 employees and no other retirement plan):

Year Under 50 Age 50 and Above
  Maximum Contribution Limit Maximum Contribution Limit
2002
2003
2004
2005
2006
$7,000
$8,000
$9,000
$10,000
$7,500
$9,000
$10,500
$12,000
$12,500

Increase the limits on deferrals to section 457 plans:

Year Maximum Deferral Limit
2002
2003
2004
2005
2006
$11,000
$12,000
$13,000
$14,000
$15,000

If you are self-employed and have a SEP-IRA or a KEOGH, in 2002 the annual limit to defined contribution plans increases from $35,000 to $40,000, (thereafter indexed for inflation in $1,000 increments). 

The maximum compensation that can be considered for determining all benefits under qualified plans is increase from $170,000 to $200,000 (thereafter indexed for inflation in $5000 increments). 

The maximum annual dollar limit on payments an individual can receive from a defined benefit pension plan will increase from $140,000 to $160,000. (thereafter indexed for inflation in $5,000 increments). Reduced dollar limits apply for individuals who retire before age 62, and increased limits are available for individuals who retire after age 65.

Effective in 2002, rollover distributions can be made from any type of qualified retirement plan, 403(b) annuity or section 457 plan to any other such plan rather than just IRA's. Additionally, distributions from an IRA would be permitted to be rolled over into one of those plan types. Employee after-tax contributions can be rolled over into another qualified plan or traditional IRA; this was not permitted under previous tax law. Certain restrictions would apply. 

The act also allows surviving spouses to roll over distributions, gives the IRS authoriity to waive the "60-day" rollover rule upon a showing hardship, and provide automatic rollover of any automatic cashout distribution of at least $1,000 into an IRA. Although the rules for rollover contributions are substantially liberalized, rollovers are not possible if the individual cannot receive a distribution form the plan or if the recipient plan does not authorize the rollover contribution.

Matching contributions made after 2001 must become fully vested after an employee has completed three years of service (down from five years)or must become vested in increments of 20 percent each year beginning with the employee's second year of service , with full vesting after six years of service (down from seven).

Effective in 2006, the Tax Relief Act allows employers to create a new type of elective deferral program called the "Qualified Roth Contribution program." This program allows participants contributing to a 401(k) plan or 403(b) annuity program the option to designate a portion of their contribution as Roth contributions. The Roth deferrals are not income tax excludable. Like Roth IRA contributions, these Roth contributions and related earnings are generally not included in gross income when distributed, provided that the distribution is not made before age 59 1/2, death, or disability. For distributions to be tax free, the individuals account must have been in existence for at least five years. Unlike Roth IRA's no distribution of Roth contributions are permitted for first-time home buyers. There are no income limits imposed on designating 401(K) deferrals as Roth contributions. The Roth contribution limit is the maximum dollar amount of elective deferrals a participant can contribute to a plan a year, but cannot exceed the total amount of deferrals contributed to plan. Special rollover rules apply to Roth contribution programs. Distribution from Roth accounts may be rolled over, but only to other Roth accounts in a 401(k) plan or 403(b) arrangement to a Roth IRA.

Effective 2002 -2006, if your adjusted income is low enough and you meet other eligibility requirements, you will receive a tax credit of up to 50% for your contribution to an IRA, 401 (k) plan, tax-deferred annuity under section 403(b), and 477deferred compensation plan of a state or local government.  

The maximum contribution that would be available as a basis for the credit would be $2,000. The credit would be in addition to any deduction or exclusion that otherwise applies to the contribution. The credit would be available to persons over 17 and under 60 years of age, other than those who are full-time students or who are claimed as a dependent on someone else's return. Distributions from retirement plans received can reduce the amount of the credit. The credit is allowable against the individuals 's regular income tax liability only. The more you make, the lower the percentage of your credit. The amount of credit would be based on adjusted gross income, according to the following schedule:

Joint Filers Heads of Household All Other Filers Credit %
AGI up to $30,000
AGI from $30,000 to $32,000
AGI from $32,000 to $50,000
AGI over $50,000
AGI to $22,500
AGI from $22,500 to $24,375
AGI from $24,375 to $37,500
AGI over $37,500
AGI to $15,000
AGI from $15,000 to $16,250
AGI from $16,250 to $25,000
AGI over $25,000
50%
20%
10%
No Credit

There is a new tax credit that provides an excellent incentive to start and/or increase contributions to a retirement plan for the benefit of employees. An employer with no more than 20 employees making $5,000 or more will be able to contribute up to 3% of their employees' salary to a retirement plan. Then, the employer will receive a tax credit for 50% of the amount contributed. 

Under the old rules, an employer would receive a tax deduction, which was calculated by multiplying their total contribution by their tax rate. For example: 20 employees multiplied by an average of $1,500 per employee = a $30,000 total contribution by the employer on behalf of his or her employees. $30,000 multiplied by a 28% tax rate would save the employer $8,400 in taxes, making the true after- tax cost of their contribution on behalf of the employees $21,600. Now, an employer contributing the same $30,000 will get a credit of 1/2 of the contribution. The credit will be worth $15,000 making the true after-tax cost of the contributions $15,000. This does not take into account savings for social security or the impact of state or local taxes.  

In addition to the credit for the contribution, there is a $500 credit for small employers who have incurred $1,000 or more to set up a new retirement plan for their employees.

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