Richest uncle now helping plump up the old nest egg

PERSONAL FINANCE

Dollars & Sense

January 13, 2002|By Eileen Ambrose

FOR THOSE resolving this new year to save more for retirement, Uncle Sam is making it easier to keep that promise.

Under the federal tax law passed last summer, workers beginning this year will be able to set aside a greater sum of money in individual retirement accounts, 401(k)s and similar plans. Older workers will be able to salt away even more.

"It certainly is an improvement and there are more options to catch up for those who have procrastinated and have denied they have a role in ensuring their own destiny," said Don Blandin, president of the American Savings Education Council in Washington.

(The laws of 14 states conflict with the new federal limits, and these states will need to conform to federal law if workers want to get state tax breaks on these higher contributions to IRAs and retirement plans, said David Wray, president of the Profit Sharing/401(k) Council of America. Maryland conforms to federal law. Still, some national companies are postponing changes to their plans until it's known whether the states will comply, Wray said. In the past, states have fallen in line with federal law, he said.)

Whether most workers will take advantage of the new options is uncertain. Up until now, many haven't made full use of retirement savings opportunities.

A survey last year by the Employee Benefit Research Institute in Washington found that only 4 percent polled said they contributed the maximum amount allowed in a retirement plan. And, a sign of the weakening economy, the percentage of people saying they saved for retirement dropped to 71 percent last year, down from 75 percent the year before.

But perhaps a new year and new resolve may inspire more workers to save. If so, here are some of the expanded savings opportunities:

Beginning this year, workers will be able to contribute as much as $11,000 to 401(k)s, 403(b)s or 457 plans. The limit rises $1,000 each year until reaching $15,000 in 2006. (Highly compensated workers may not be able to put in the new 401(k)limits because their contributions remain tied to how much lower-paid workers kick in.)

Maximum contribution to an IRA also goes up from $2,000 to $3,000 this year through 2004. The cap rises to $4,000 in 2005 through 2007 and to $5,000 in 2008.

Another good change is that IRA contributions also now will be adjusted to keep up with inflation, just like 401(k) contributions have been, said Nicholas Kaster, a pension and IRA analyst with CCH Inc., an Illinois tax information company. "IRA limits were frozen at that $2,000 limit for such a long, long time [that] for any real sense they were not worth a whole lot," he said.

Workers 50 and older will be able to set aside even more than these new limits under so-called "catch-up" provisions. This year through 2005, these workers can set aside up to $500 extra in an IRA, and up to $1,000 more each year beginning in 2006. That means a 55-year-old can set aside $3,500 in an IRA this year and as much as $6,000 in 2008.

The catch-up is more generous for 401(k), 403(b) and 457 plans, although an employer will have to change its plan to permit catch-up contributions, Kaster said.

With a catch-up, older workers will be able to set aside an additional $1,000 this year, an extra $2,000 next year, $3,000 in 2004, $4,000 in 2005 and $5,000 in 2006 and beyond. So, when younger workers are salting away as much as $15,000 in 2006, older colleagues can save as much as $20,000.

The tax law also created a credit to encourage lower-income taxpayers to put money into an IRA or other retirement plan. The credit disappears after 2006. Eligible taxpayers can get a credit worth 10 percent, 20 percent or 50 percent of the first $2,000 contributed, depending on their income.

The largest credit, for example, goes to a married couple with adjusted gross income of up to $30,000, a head of household with income up to $22,500 and singles with income of $15,000 or less.

A credit reduces your bottom-line tax bill dollar-for-dollar, making it better than a tax deduction. "If your income is so low you don't have a tax liability, this isn't of help to you," Kaster said.

So, with all these new savings opportunities, where do you start?

For most workers, the first place to invest for retirement should be a 401(k) or similar plan that has an employer match, which is free money, experts said.

"If you're getting an employer match, you want to do everything you can to get that match," said Ted Benna, president of the 401(k) Association, a retirement consulting firm in Jersey Shore, Pa.

Disciplined savers with poor investment options in their 401(k) may want to consider putting enough money into the plan to get the match and then investing in, say, an IRA, which offers a wide choice of investments and tax breaks, Benna said. But, he added, too many workers don't have the discipline and are better off maxing out on their 401(k) first.

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