Tax Relief Only an Accountant Could Love


By Ellen Hoffman Much has been made about the benefits -- especially those much-anticipated refund checks -- of the new tax law. When it comes to pensions and retirement, however, there are two things you should count on: The tax code just got more complicated, and your retirement accounts won't benefit much in the near future.

First things first. An already mind-numbingly complex system just got worse. People who already have trouble choosing between a Roth and a traditional IRA, or figuring out how much they can legally contribute to their 401(k), will now find such decisions even more of a headache. That's because Congress has added several new types of retirement savings programs and policies, as well as changed some of the old ones.

Second, don't expect this tax bill to boost your retirement savings for several years -- and maybe not even then, unless the market again catapults small investments into mammoth returns. There are several reasons for this: The benefits from the bill are being phased in slowly. As of now, all parts of the tax bill will end Dec. 31, 2010, and some members of Congress are already suggesting that parts of the tax bill may have to be repealed to meet other budget priorities. Also, some of the changes aren't all that dramatic, at least at first. It usually takes a long time for $500 -- the extra amount you can initially contribute to your 401(k) under the new rules -- to grow into a significant amount.

That said, people who fall into one or more of the following categories probably will eventually benefit from various changes in the new law:

To-the-Limit Savers: If you have a retirement savings account, such as a 401(k) or an IRA, you'll be able to increase the size of your annual tax-deferred contributions. The amount and schedule for the increase varies with the type of plan you have, but none of the limits start to increase until 2002.

Because of the complexity of the new law, I suggest that you shouldn't assume much in the way of change beyond what's scheduled for next year. When planning your budget for 2002, the most important step you can take now is to set aside money for the additional tax-deferred contributions that will be available.

For starters, in 2002 you'll be able to contribute up to $3,000 into a traditional or a Roth IRA, or a combination of both, compared to a maximum of $2,000 now. (You can calculate the impact of the higher contribution limits on your own savings by visiting BusinessWeek Online's "Personal Finance" page and then clicking on "Retirement Calculators" and "Roth IRA Calculators.")

If you have a 401(k), a 403(b), or a 457(b), you'll be able to make a tax-deferred contribution of up to $11,000, vs. $10,500 for this year. Small-business owners or employees could increase their contributions to a SIMPLE plan from $6,500 this year to $7,000 in 2002.

The contribution limits for all of these plans will continue to rise between 2002 and 2010. However, the phase-ins occur at different rates. For example, the IRA contribution limit will top out at $5,000 in 2008 (with inflation increases later), but the limit of $15,000 for 401(k)s will be reached in 2006.

The new law also creates a plan called a "Roth 401(k)." Under this option -- which won't be available until 2006 -- you'll pay taxes on the contribution when you make it, but you won't have to pay tax upon withdrawal. John Scott, director of retirement policy for the American Benefits Council, which represents large employers, says that current 401(k) participants who want to put money into the new Roth would probably "end up with two separate accounts: one for pre-tax contributions and one for after-tax contributions."

People 50 and Older: If you're in this age bracket, you should take advantage of some innovative new provisions to beef up your IRA, 401(k), 403(b), or SIMPLE plan as your retirement date approaches. Politicians often refer to the catch-up concept as "enhancing fairness for women and expanding coverage," because women are more likely than men to spend time out of the workforce, and, on average, they have smaller retirement nest eggs. As long as you meet the age requirement, you qualify for extra tax-deferred savings.

Here's how it works: From 2002 through 2005, you may put an annual $500 "catch-up contribution" over the other new limit into an IRA. In 2006 and thereafter, the amount will be $1,000 yearly. Annual catch-up amounts for the SIMPLE plan start at $1,000 in 2002 and end at $5,000 in 2006. For a 401(k) or 403(b), the catch-up amount is half as much -- starting at $500 in 2002 and increasing to $2,500 in 2005.

How much could the catch-up contribution be worth to you when you retire? If you put $500 extra into your IRA next year and that money earned 8% for 10 years until you retired, you'd have $9,147. After 15 years, you'd have $17,302. A 401(k) catch-up contribution of $1,000, allowed to accumulate at 8% for 10 years, would net $15,184 -- $28,721 if you didn't touch it for 15 years. And of course, if you add catch-up money every year for 10 or 15 years, the amount by which you could boost your nest egg would be multiplied many times over.

Moderate-Income Earners: If you're just entering the workforce, you may qualify for a new tax credit for a portion of the contributions you make to a 401(k), 403(b), 457(b), or IRA, but only from 2002 through 2006. A tax credit ranging from 10% to 50% of your contribution will be available to individuals earning up to $25,000. For married couples filing jointly, the income limit goes to $50,000.

Job-Changers: Any time you leave your job, you have a right to take the money you contributed to your 401(k) or similar plan with you. Now, your employer's contributions are vested either in five years or at the rate of 20% per year starting in your third year on the job. Under the new law, starting in 2002, you'll be fully vested in three years, or after six years of vesting in increments, instead of seven.

Uninformed Employees: If your employer institutes a cash-balance plan or otherwise changes your retirement plan in a way that could result in a "significant reduction" in the rate at which your retirement fund will grow, the new law requires that the company notify you "within a reasonable time" before implementation. Your employer must inform you about the potential effects of the change on your retirement benefits, including the impact on early retirement benefits. An employer who fails to do this could be penalized up to $100 per day for each person who should be notified and is not. The new rules also prohibit employers who do not provide notice from putting the cuts into effect.

Specifics, such as how far ahead you must be notified and what information you must be given, will be worked out in regulations to be issued by the government. Your employer is only required to notify you 15 days before such a change goes into effect, and there's no requirement to explain termination of the early retirement benefits.

Accountants: I'm not the first to call this new law the "Tax Accountants' Relief Act," and I won't be the last. But as all the provisions -- not only the ones mentioned here -- of the "Economic Growth and Tax Relief Reconciliation Act of 2001" go into effect, you'll not only need an accountant -- you'll probably wish you had taken the time to earn that CPA credential yourself. Hoffman, author of The Retirement Catch-Up Guide, writes Your Retirement monthly, only for BW Online


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