Broker Check

August 15, 2001


          This is the second part of the discussion of The Economic Growth and Tax Relief Reconciliation Act of 2001. This month`s newsletter will discuss the Retirement and Education savings aspects of the Act. Last month we discussed the Income Tax aspects. Next month we wil discuss the Estate and Gift tax changes.

a/k/a Education IRAs

          An Education IRA is not really an IRA as we normally understand an IRA to be. It is a misnomer, it is instead, a trust or custodial account established to pay for certain education expenses of a named beneficiary. Like Roth IRAs, contributions to these IRAs are not deductible when computing taxable income and the earnings of the IRA generally are not includable in gross income in the year of the distribution if used to pay the eligible expenses of the beneficiary. It was generally ignored because the contribution limit was only $500 and most financial institutions did not bother to have a prototype account that you could use.

          Starting in 2002, the annual limit rises to $2,000 and the definition of eligible expenses that may be paid tax free from the Education IRA will include elementary and secondary school expenses as well as higher education. As a result, these accounts will be more useful as a means of saving to pay the education expenses of beneficiaries. Additionally, the Hope Scholarship Credit or the Lifetime Learning Credit can be used regardless of whether there are distributions used from this account. Even the name is changed to more accurately reflect its status, no longer an IRA; it`s the Cloverdell Education Savings Account.

Higher Education Expenses

          Starting in 2002 through 2005, eligible taxpayers will be able to claim an above the line deduction for qualified higher education expenses.

529 Plans

          Distributions from state prepaid tuition plans will be tax free in 2002 if used for college.

IRA Contributions

          The current $2,000 limitation on contributions to an IRA (Roth and Traditional) will increase to $3,000 for 2002-2004, $4,000 for 2005-2007 and $5,000 for 2008 and beyond. An additional contribution can be made for individuals who are 50 or older by the end of 2002. The additional amount is $500 for 2002-2005 and $1,000 for 2006 and beyond.

          Thus, the maximum annual IRA deduction for those 50 or older will be as follows:

              Tax Years        Amount                 Tax Years            Amount
              2002-2004        $3,500                  2006-2007          $5,000
              2005                $4,000                 2008 and later      $6,000

Limits on 401(k), 457 and 403(b) Elective Deferrals

          The elective deferral limit for Section 401(k) plans, Section 403(b) plans and Section 457 plans will increase to $11,000 in 2002, $12,000 in 2003, $13,000 in 2004, $14,000 in 2005 and $15,000 in 2006 with cost of living increases in $500 multiples, thereafter.

          An additional contribution can be made by participants who have reached 50 by the end of the year. The additional amount is $1,000 for 2002, $2,000 for 2003, $3,000 for 2004, $4,000 for 2005 and $5,000 for 2006 and later years.

          Thus, for individuals 50 or older, the 401(k), 403(b) and 457 limits are:

              Tax Years          Amount                Tax Years          Amount
              2002                  $12,000               2005                  $18,000
              2003                  $14,000               2006                  $20,000 
              2004                  $16,000

Qualified Plan Compensation

          Under current rules, qualified plans can take into account no more than $170,000 of an employee`s compensation for purposes of calculating contributions and nondiscrimination tests. This will increase to $200,000 for years after 2001 and will continue to be indexed for inflation after that.

Annual Additions to Defined Contribution Plans

          Presently, the annual addition to a participant`s account in a defined contribution plan is limited to the lesser of 25% of the employee`s compensation or $35,000. Effective after 2001, this will increase to the lesser of 100% of the employee`s compensation or $40,000.

Limits on Employer Deductions to Qualified Plans

          The limit on the amount an employer can claim as a deduction for contributions to a qualified profit sharing or stock bonus plan is currently 15% of total compensation of employees covered by the plan and employee elective deferrals are included in the amount of the contribution subject to the limit. For years after 2001, the limit increases to 25% of total compensation. In addition, employee elective deferrals will not be subject to the limits because profit sharing plans will have the same contribution limit as Money Purchase Plans. Contribution flexibility can be obtained by replacing or terminating your Money Purchase Plan.

Credit for Contributions to Qualified Plans

          A new nonrefundable credit is available for years after 2001 and before 2007 for certain lower income taxpayers based on contributions to a qualified plan. The maximum amount of contribution eligible for the credit is $2,000. The credit percentage begins at 50% and begins to be phased out for joint filers with AGI of $30,000 and is fully phased out at $50,000 AGI. For single filers, the amounts are halved. The credit is applied to contributions to a 401(k), a 403(b), and 457 plans, a SIMPLE, a SEP, contributions to an IRA or Roth IRA and voluntary after tax contributions to a qualified retirement plan.

Pension Portability

          For distributions after 2001, eligible distributions may be rolled over to or from any qualified plan, 403(b) plan, 457 plan and some IRAs. For example, now a 457 plan or a 403(b) plan may be rolled over into an IRA.

          In addition, the Treasury Secretary has been granted authority to designate certain circumstances in which the requirements that rollovers must be completed within 60 days of receipt to avoid current tax may be waived.

          If you would like more details about how any of these new rules might be used to your advantage please call me. Remember, We`re Here For You!!