ElectroFile Tax Info Newsletter -- Now you can build a bigger nest egg

Tax Info Newsletter

Dated: 02/27/2002

Now you can build a bigger nest egg

Starting this year, you can tuck away a lot more money into 401(k)s and other tax-favored retirement plans. You can even play catch-up if you’re 50 or older.

If the holiday season set you back more than you had planned, here’s some good news that might take the edge off as the credit card bills start rolling in.

This year, you can sink far more into tax-favored retirement savings plans, thanks to increases in contribution limits that are called for by last year’s big tax cut bill -- the Economic Growth and Tax Relief Reconciliation Act of 2001, for those who like to be technical about these things.

The increases, the biggest ever, enable you to take a big leap forward in building your nest egg.

“This is great news for people who feel they are behind in their savings. They’ll be able to make much more headway,” says Ron Roge, an investment adviser in Bohemia, N.Y.

For years investors and advisers have complained that contribution limits were too low, says Clint Stretch, director of tax legislative affairs at Deloitte & Touche in Washington, D.C. While 401(k) limits have risen more or less in tandem with inflation, usually in $500 increments, IRA limits of $2,000 a year were set in 1981 and have never been adjusted.

Under the new law, contribution limits to all kinds of retirement plans -- from 401(k)s to IRAs -- are scheduled to rise in increments over the next four to six years. Once they have been phased in, future increases will be indexed to inflation.

The new rules

Here’s how the retirement-saving environment is changing:

Individual Retirement Accounts and Roth IRAs. Contribution limits for regular IRAs and Roth IRAs are $3,000 this year, up from $2,000. “This is a big deal -- for married couples, it’s really $6,000 that you can put in an IRA account,” Roge says.
If you’re skeptical about what difference an extra $1,000 a year in savings can make per person, take a look at the numbers: If you squirrel away the maximum $3,000 each year for 30 years and earn an average 8% annual return, you’ll end up with $339,849, Roge says. Under the old rules, investing $2,000 a year, you would have accumulated $226,556 in that period.
IRA contribution limits will rise by $1,000 again in 2005, and once more in 2008 to $5,000.
401(k) and 403(b) accounts. The maximum you can put in this year into these hugely popular employer-sponsored retirement plans is $11,000, up from $10,500 in 2001. The limits will continue to go up in $1,000 increments each year until maxing out at $15,000 in 2006.
SIMPLE plans. Investors in these retirement plans, offered by employers with fewer than 100 employees, can put in $7,000 this year vs. $6,500 in 2001. If you’re self-employed, you can invest in a SIMPLE plan, or significantly boost your contributions with a SEP (simplified employee pension IRA). This year, you can invest 25% of earnings up to $200,000 in a SEP, with a cap of $40,000. In 2001, the maximum was 15% of earnings up to $170,000.
A bonus if you’re 50 or older. The biggest retirement savings benefits go to people aged 50 and over. Thanks to so-called catch-up provisions in the new tax law, they can contribute more to their retirement plans than most folks. Starting this year, they can invest a maximum of $3,500 in an IRA or a maximum of $12,000 in a 401(k). (In 2003, the maximum 401(k) limit with the bonus goes to $14,000 -- $12,000 plus a $2,000 catch-up contribution.)

To get the most out of the new changes, your top priority should be to invest the maximum in your 401(k) or 403(b) plan, if you are eligible for one. Contributions in 401(k)s are made with pre-tax money, and often employers will match a portion of what you put in. These benefits make a 401(k) too good to pass up.

What’s more, the new law accelerates the vesting of employers’ matching contributions -- that is, the full rights to an employer’s match. “In the past, company matches had to be fully vested after five years, or according to a phase-in schedule lasting seven years,” says Bill Arnone, director of employee financial education at Ernst & Young in New York.

Starting this year, employers must either grant 100% vesting after no more than three years or adopt this phase-in schedule: 20% after two years, 40% after three years, 60% after four years, 80% after five years and 100% after six years. Keep in mind, though, that the new vesting rules apply only to contributions starting this year, Arnone says.

What if you don’t have a 401(k)?

If you aren’t eligible for a 401(k), your first priority should be to contribute whatever retirement plan your employer makes available to you -- a 403(b), SEP or SIMPLE plan. If you’re self-employed, you can invest in an SEP or SIMPLE. Like the 401(k), these plans allow pre-tax contributions, and your money grows tax deferred.

So you can pat yourself on the back if you manage to contribute the maximum to your 401(k) or a similar plan. But don’t stop there.

Love that IRA

Once you have maxed out, see if you can’t squeeze out some more savings for an IRA.

Your best bet is to invest in a Roth IRA, because your investments grow tax-free and you can take the money out tax-free. But there are income restrictions: You can only invest in a Roth if your adjusted gross income is $110,000 or less if you are single, or $160,000 or less if married.

There are two kinds of regular IRAs -- deductible and non-deductible. In both cases, your money grows tax-deferred. The added benefit to the deductible IRA is that your contributions are tax-deductible.

If you aren’t eligible for another retirement savings plan, you can contribute to a deductible IRA regardless of income. But if you can participate in another plan, to qualify for a deductible IRA, your adjusted gross income cannot exceed $44,000 for singles or $64,000 for couples. If your spouse is a participant in another retirement plan, but you aren’t, you’re still eligible for a deductible IRA if your combined income doesn’t exceed $160,000.

A non-deductible IRA has no income restrictions.

Even if you can’t max out on IRA contributions, sock away what you can -- and don’t wait until the end of the year, says Lisa Osofsky, a tax adviser at M.R. Weiser & Co. in New York. “That way you get a head start -- set it aside early and you’ll get the whole year of tax-deferred growth,” she says. “As long as you have the cash to invest, it’d be nuts not to get the most out of the breaks the government is handing you.”

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All information provided is general in nature and intended to create awareness, not to address the specific circumstances or concerns of any individual or entity. Although we try to provide correct and timely information, we cannot guarantee the accuracy of any information or that such information will continue to be accurate in the future due to the changing nature of the tax laws. Before acting on any of the information provided here, you should consult with a professional advisor who knows all of the unique facts and circumstances pertinent to your particular situation.