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2001
Tax Act: Retirement Plan Changes |
Although
the 2001 Act’s tax rate cuts and estate and gift tax changes
have received top billing in the media, the many retirement
plan changes in the new law deserve at least equal attention.
Virtually every important dollar figure and percentage limit
has been increased, and many other favorable changes have been
made. The net result is that beginning next year, many employees
who are covered by a company retire-ment plan will have better
tools with which to build a secure retirement future. That includes
CEOs of major corporations, owner-employees of closely-held
corporations, middle managers and regular employees, including
those in the lower-paid group.
Here is a roundup of how the 2001 Tax Act will help employees
build a more financially secure retirement future.
Highly Paid Employees
There is a dollar limit on how much of an employee’s compensation
can be taken into account when figuring various limitations
on employer-sponsored retirement plans, such as maximum annual
contributions or pensions. This year, the limit is $170,000,
but next year it will be $200,000.
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Example:
A corporation’s profit-sharing plan contributes 10%
of each participating employee’s salary to his or
her plan account. One of its employees earns $250,000.
This year, the corporation can contribute $17,000 to his
account (10% of $170,000). Next year, its contribution
for the employee will be $20,000 (10% of $200,000). |
Two
important annual limits apply to defined contribution plans,
such as profit-sharing and stock-bonus arrangements. One restricts
the total amount that can be contributed by the employer and
employee to each plan participant’s account, and the other
restricts the amount of the contribution that can be deducted.
This year, the maximum amount that can be contributed to each
participant’s account is 25% of compensation or, if less,
$35,000. The maximum deductible contribution is 15% of the compensation
paid to all employees covered by the plan.
Next year, the maximum that can be contributed to each participant’s
account is 100% of compensation capped at $40,000. The maximum
deductible contribution will be 25% of the compensation paid
to all employees covered by the plan.
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Example:
An architect has an incorporated practice that maintains
a profit-sharing plan. He is the only employee and his
annual compensation is $160,000. This year, the practice
may contribute $40,000 to the architect’s account,
but it may deduct only $24,000 of the contribution (15%
of $160,000). Next year, it can deduct $40,000 (25% of
$160,000). |
Companies that maintain regular pension plans (those that pay
a fixed annual or monthly amount when the employee retires)
will be able to make larger pension payments. The maximum pension
that a plan can fund is 100% of a participating employee’s
average compensation for his three highest-paid years, limited
by a dollar cap. This year, that dollar cap is $140,000, but
next year it will rise to $160,000.
Regular Wage Earners
The changes for 401(k) plans (also known as cash-or-deferred
arrangements) are the most important ones for regular wage earners.
There are five major changes you should be aware of:
1. There is a limit on how many
pre-tax wage dollars you can defer each year. This year, the
maximum is $10,500, but it will rise to $11,000 in 2002, and
then rise in $1,000 annual increments until it reaches $15,000
in 2006. [These maximums also apply to 403(b) annuities, and
salary reduction SEPs (Simplified Employee Pensions)].
2. A new concept called "catch-up"
contributions will allow employees who are 50 or older to make
additional annual deferrals of pre-tax dollars. The maximum
catch-up contribution for 401(k) plans (as well as for 403(b)
annuities, and salary reduc-tion SEPs) will be $1,000 for 2002,
$2,000 for 2003, $3,000 for 2004, $4,000 for 2005, and $5,000
for 2006 and later years. As a bonus, the catch-up contribu-tions
will not be subject to the various limitations and requirements
that normally apply to elective deferrals.
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Example:
A company’s 401(k) plan allows employees to make
elective deferrals up to 10% of compensation or the annual
dollar limit, whichever is less. One of its employees,
age 51, makes $70,000 a year. Next year, she can make
a regular elective deferral of $7,000, plus an additional
elective deferral of $1,000. For 2006, she can make an
additional elective deferral of $5,000. |
3. Beginning next year, an employee’s
elective deferrals to a 401(k) plan will not be subject to the
deduction limits for stock bonus and profit-sharing plans (this
year, they are subject to the generally applicable deduction
limits). This will make it feasible for companies to allow employees
to make larger elective deferrals (or to increase the company
contribution).
4. Beginning next year, elective deferrals (as well as
an employee’s elective set-asides in a cafeteria plan)
will be treated as "compensation" for purposes of
applying the deduction limits that apply to profit-sharing and
stock bonus plans [as well as some other types of plans, such
as employee stock ownership plans (ESOPs)]. This year, these
deferrals are not treated as "compensation."
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Example:
A company maintains a profit-sharing plan. It also has
a 401(k) plan that allows employees to make elective deferrals
up to 6% of salary. One of its employees earns $50,000
and makes a maximum 401(k) elective deferral of $3,000.
(We will assume all the other employees also make the
maximum deferral.) Beginning next year, the company can
deduct up to $12,500 for (1) contributions to the employee’s
profit-sharing account, plus (2) matching contributions
to her 401(k) account ($12,500 is 25% of $50,000). This
year, the company can deduct no more than $7,050 in profit-sharing
and matching 401(k) contributions [$7,050 is 15% of ($50,000
minus $3,000 elective contribution)]. |
5.
Any matching contributions that your company makes to your 40(k)
account will have to vest at a faster pace. Currently, you must
be 100% vested in matching contributions after (a) five years
of service, or (b) after seven years, if you are 20% vested
after three years, plus an additional 20% for each subsequent
year. For next year’s contributions, you must be 100% vested
in matching contributions after (a) three years of service,
or (b) after six years (20% vested after two years, plus an
additional 20% for each subsequent year).
Faster vesting aids employees who move from job to job. Keep
in mind that your employer may have a more rapid vesting schedule
for matching contributions, but it cannot use a slower one than
the tax law requires.
Lower-Income Employees
For 2002 through 2006, lower-income wage earners will get an
unprecedented incentive to save for retirement. It will come
in the form of a nonrefundable credit of up to 50% of elective
contributions to employer plans or IRAs, in addition to any
deduction or exclusion that would apply. The maximum annual
contribution eligible for the credit is $2,000. The credit rate
(50%, 20%, or 10%) depends on the taxpayer’s filing status
and AGI. For example, a joint filer with up to $30,000 AGI gets
a 50% credit. The credit drops to 20% if AGI is $30,000 to $32,500,
and to 10% if AGI is $32,500 to $50,000. There is no credit
for joint filers if AGI is above $50,000.
Only an individual who is 18 or over (other than a full-time
student, or someone allowed as a dependent on another taxpayer’s
return for the year) will be eligible for the credit. Special
anti-abuse provisions will apply.
August 10, 2001
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