IRA Owners Get New Savings Breaks in Tax Bill

By Clifton Linton
Senior Writer, mPower

In This Story New Contribution Limits Automatic Rollovers Education Savings Retirement Charity

Reversing the trend of more restrictions on IRA usage, Congress and the President have approved a new set of rules which should make this stalwart of retirement savings more attractive to use.

The IRA was originally designed for American workers to use to save for retirement. But over the years, Congress has imposed restrictions on the number of folks that could make tax-deductible contributions and the retirement savings focus has shifted to employer plans like 401(k)s. Still, the IRA is the main tax-advantaged savings plan for workers without an employer-sponsored plan.

minute: read this article at a glance.

Technical Terms 401(k) plan Roth IRA

With the enactment of President Bush's tax bill, this bedrock of retirement savings is getting a face-lift.

The new rules boost the annual maximum contribution limit, make it easier for savers to combine assets in IRAs and employer-savings plans, offer a tax credit to low-income savers, and permit new catch-up contributions for workers over age 50.

Here's a review of the new laws set to take effect January 1, 2002.

New Contribution Limits

The most significant change to the IRA regulations is the increase in the maximum annual contribution limit. The limit has been fixed at $2,000 for more than a decade. In 2002, the annual limit for both traditional and Roth IRAs will rise to $3,000. In 2005, it will rise to $4,000 and in 2008, it will reach $5,000. Thereafter, further increases will be indexed to inflation.

Additionally, the new regulations call for the maximum annual contribution limit for SIMPLE IRAs to rise to $10,000 by 2005 from the current $6,500 a year. The limit will rise by $1,000 a year from 2002 to 2005, and further increases will be indexed to inflation.

For SEP-IRAs, the maximum annual contribution limits will change to the lesser of $40,000 or 100 percent of salary. Currently, the limit is the lesser of $35,000 or 15 percent of salary.

Other significant changes involve what is known as "portability," or the ability to move your money from one tax-deferred retirement account to another. State and local government workers with 457 deferred comp plans will be able to roll their 457 money into an IRA when they leave their job — something they were not allowed to do previously. Also, a worker who rolled a 401(k) into an IRA, then wanted to roll that into a 403(b) at a new employer, previously could not do so. Now that will be allowed. Finally, pretax contributions that were made directly to an IRA can be moved into an employer's retirement plan such as a 401(k), 403(b) or 457 if you want to consolidate your retirement money.

For workers who didn't have a chance to get a jump on saving for retirement early in their working career, new catch-up contributions have been added. Once a worker reaches age 50, she will be able to make an additional IRA contribution each year. From 2002 to 2005, it will be an extra $500. The catch-up contribution will rise to $1,000 a year starting in 2006.

Low-income workers will find that the new law contains an added incentive to save. From 2002 to 2006, low-income workers may be able to qualify for a non-refundable tax credit on the first $2,000 in savings contributions. Here's how it will work:

• Individuals with up to $15,000 a year in adjusted gross income (AGI) and couples filing jointly with AGI up to $30,000, will be eligible for a 50 percent credit on $2,000 in contributions.
• Individuals with AGI between $15,001 and $16,250 and couples filing jointly with AGI between $30,001 and $32,500 will be eligible for a 20 percent credit.
• Individuals with AGI between $16,251 and $25,000 and couples filing jointly with AGI between $32,501 and $50,000 will be eligible for a 10 percent credit.

Automatic Rollovers

Under the new laws, employers will be required to roll over departing employees' 401(k) balances into an IRA if the balances are between $1,000 and $4,999, unless the employee requests cash. This addresses a troubling trend — the tendency for workers to cash out their retirement savings when they change jobs. Sixty-eight percent of employees opted to take a cash payout from their 401(k) plan when changing jobs, according to a study released in 2000 by benefits firm Hewitt Associates.

Retirement industry trade groups worried that many people were short-changing their retirement future. They lobbied Congress to include this new provision.

Education Savings

Also tucked into the tax bill were changes to Education IRAs and tax-deferred college savings plans.

Education IRAs will be renamed Education Savings Accounts to accurately reflect their purpose. The annual contribution limit will be quadrupled, rising to $2,000 instead of $500, per child. Further, families will be able to withdraw savings from the accounts for elementary and high school costs as well as college.

Related Reading College Savings Plans 101 Education IRA Limits May Increase GOP Looks to Raise Annual IRA Contributions to $5,000 Talking With a Chief Architect of Pension Reform Legislation

The new regulations should also give a boost to state-run 529 college savings plans. Under current rules, the after-tax money saved in these plans grows tax-deferred, but withdrawals are subject to federal income tax. Under the new rules, withdrawals will be tax-free.

Retirement Charity

There's also a new rule concerning distributions in retirement, but it doesn't take effect until 2010. Traditionally, IRA withdrawals made for the purposes of charitable donation have been at least partially taxed. Under the new rules, withdrawals that are transferred directly to a charity or charitable trust will be excluded from gross income for folks older than age 70½ who are taking required minimum distributions. 

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

IRA Owners Get New Savings Breaks in Tax Bill

By Clifton Linton
Senior Writer, mPower

In This Story New Contribution Limits Automatic Rollovers Education Savings Retirement Charity

Reversing the trend of more restrictions on IRA usage, Congress and the President have approved a new set of rules which should make this stalwart of retirement savings more attractive to use.

The IRA was originally designed for American workers to use to save for retirement. But over the years, Congress has imposed restrictions on the number of folks that could make tax-deductible contributions and the retirement savings focus has shifted to employer plans like 401(k)s. Still, the IRA is the main tax-advantaged savings plan for workers without an employer-sponsored plan.

minute: read this article at a glance.

Technical Terms 401(k) plan Roth IRA

With the enactment of President Bush's tax bill, this bedrock of retirement savings is getting a face-lift.

The new rules boost the annual maximum contribution limit, make it easier for savers to combine assets in IRAs and employer-savings plans, offer a tax credit to low-income savers, and permit new catch-up contributions for workers over age 50.

Here's a review of the new laws set to take effect January 1, 2002.

New Contribution Limits

The most significant change to the IRA regulations is the increase in the maximum annual contribution limit. The limit has been fixed at $2,000 for more than a decade. In 2002, the annual limit for both traditional and Roth IRAs will rise to $3,000. In 2005, it will rise to $4,000 and in 2008, it will reach $5,000. Thereafter, further increases will be indexed to inflation.

Additionally, the new regulations call for the maximum annual contribution limit for SIMPLE IRAs to rise to $10,000 by 2005 from the current $6,500 a year. The limit will rise by $1,000 a year from 2002 to 2005, and further increases will be indexed to inflation.

For SEP-IRAs, the maximum annual contribution limits will change to the lesser of $40,000 or 100 percent of salary. Currently, the limit is the lesser of $35,000 or 15 percent of salary.

Other significant changes involve what is known as "portability," or the ability to move your money from one tax-deferred retirement account to another. State and local government workers with 457 deferred comp plans will be able to roll their 457 money into an IRA when they leave their job — something they were not allowed to do previously. Also, a worker who rolled a 401(k) into an IRA, then wanted to roll that into a 403(b) at a new employer, previously could not do so. Now that will be allowed. Finally, pretax contributions that were made directly to an IRA can be moved into an employer's retirement plan such as a 401(k), 403(b) or 457 if you want to consolidate your retirement money.

For workers who didn't have a chance to get a jump on saving for retirement early in their working career, new catch-up contributions have been added. Once a worker reaches age 50, she will be able to make an additional IRA contribution each year. From 2002 to 2005, it will be an extra $500. The catch-up contribution will rise to $1,000 a year starting in 2006.

Low-income workers will find that the new law contains an added incentive to save. From 2002 to 2006, low-income workers may be able to qualify for a non-refundable tax credit on the first $2,000 in savings contributions. Here's how it will work:

• Individuals with up to $15,000 a year in adjusted gross income (AGI) and couples filing jointly with AGI up to $30,000, will be eligible for a 50 percent credit on $2,000 in contributions.
• Individuals with AGI between $15,001 and $16,250 and couples filing jointly with AGI between $30,001 and $32,500 will be eligible for a 20 percent credit.
• Individuals with AGI between $16,251 and $25,000 and couples filing jointly with AGI between $32,501 and $50,000 will be eligible for a 10 percent credit.

Automatic Rollovers

Under the new laws, employers will be required to roll over departing employees' 401(k) balances into an IRA if the balances are between $1,000 and $4,999, unless the employee requests cash. This addresses a troubling trend — the tendency for workers to cash out their retirement savings when they change jobs. Sixty-eight percent of employees opted to take a cash payout from their 401(k) plan when changing jobs, according to a study released in 2000 by benefits firm Hewitt Associates.

Retirement industry trade groups worried that many people were short-changing their retirement future. They lobbied Congress to include this new provision.

Education Savings

Also tucked into the tax bill were changes to Education IRAs and tax-deferred college savings plans.

Education IRAs will be renamed Education Savings Accounts to accurately reflect their purpose. The annual contribution limit will be quadrupled, rising to $2,000 instead of $500, per child. Further, families will be able to withdraw savings from the accounts for elementary and high school costs as well as college.

Related Reading College Savings Plans 101 Education IRA Limits May Increase GOP Looks to Raise Annual IRA Contributions to $5,000 Talking With a Chief Architect of Pension Reform Legislation

The new regulations should also give a boost to state-run 529 college savings plans. Under current rules, the after-tax money saved in these plans grows tax-deferred, but withdrawals are subject to federal income tax. Under the new rules, withdrawals will be tax-free.

Retirement Charity

There's also a new rule concerning distributions in retirement, but it doesn't take effect until 2010. Traditionally, IRA withdrawals made for the purposes of charitable donation have been at least partially taxed. Under the new rules, withdrawals that are transferred directly to a charity or charitable trust will be excluded from gross income for folks older than age 70½ who are taking required minimum distributions. 

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.