Millions of workers around the nation can sock away bigger nest eggs in their 401(k) and similar retirement savings plans in 2004, thanks to tax-law changes of recent years. And workers 50 and older can put away even more.
The 2001 tax cut loosened the restrictions on 401(k) plans, allowing many workers to boost contributions sharply, and easing the rules on employers so that better-paid workers are less likely to run afoul of antidiscrimination requirements.
For 2004, workers can dump as much as $13,000 into their plans, and those 50 and older can toss in another $3,000, for a total this year of $16,000. And, thanks to a technical correction in 2002, workers who turn 50 can make the full "catch-up" contribution, even if their birthdays are late in the year.
Contribution limits on individual retirement accounts remain the same in 2004 as 2003 -- $3,000, plus a $500 catch-up for those 50 and older -- but the deduction ceiling has been eased slightly. This year, people who are covered by retirement plans at work may deduct IRA contributions even if their incomes are as high as $55,000 ($75,000 if married filing jointly), up $5,000 from 2003.
All of the various contribution limits are scheduled for further rises over the coming years, so that by 2008 a worker 50 and over could contribute $20,000 to his or her 401(k) plan and another $6,000 to an IRA. Two-earner couples could conceivably contribute twice as much.
Some restrictions on 401(k) plan contributions remain, principally for "highly compensated employees," those making more than $90,000. But those limits do not apply to the catch-up portion.
But these retirement vehicles are far from the only tax-preferred vehicles out there these days.
Not only can families now save tax-free for college, through Section 529 and Coverdell education savings accounts, but in the Medicare bill Congress also authorized health savings accounts -- with tax-deductible funding along with potentially tax-free earnings -- for people with high-deductible medical insurance.
The effect for most middle-income families is that tax-preferred saving for retirement and a variety of other purposes will be limited more by their ability to spare the cash than by ceilings in the law.
Thus, it has become more critical than ever for families to try to look down the road at their long-term needs and goals and match them up as best they can with the available tax benefits. Lower-paid workers should also remember that there is a "saver's credit" of up to 50 percent for money they put into a 401(k) or similar plan.
Some keys to remember are:
• The impact of time. The benefits of compounding increase sharply over time. Saving a modest amount at age 25 can add up to far more at age 65 than saving a large amount starting at age 45. So start now, even if you can afford only a small sum. Whether saving for the kids' college or your own retirement, slow and steady is surprisingly effective if you do it long enough.
• Non-tax benefits. Many employers offer to match part of workers' 401(k) contributions, but still many workers don't participate. They should. Even if it is a squeeze on the family budget, an employee shouldn't pass up a company match. It's free money.
• Consistency. The biggest mistake most people make in retirement saving is taking their money out of the plan when they change jobs. The employer offers them the cash, they take it, spend it and it's gone. This sets the compounding clock back to zero, and there are taxes on top of it. So if you are changing jobs, don't be tempted. Roll your account balance into a plan at your new employer, if you can. If you can't or if you don't like the new plan's investment options, roll it over into an individual retirement account. In fact, Congress made rollover to an IRA the "default option" for accounts over $1,000, meaning your employer has to do that unless you instruct it otherwise.
The Internal Revenue Service said last week it is designating as abusive tax shelters certain gimmicks in which small-business owners shift stock, property or other business assets into Roth IRAs. That maneuver would be a great idea if it were legal, since earnings and profits in Roth IRAs are tax-free.
There are a number of limitations on Roth IRAs, one of which is that annual contributions cannot exceed $3,000, or $3,500 for people 50 and older. The IRS has discovered that some people are trying to get around this and other rules by setting up shell companies that are owned or acquired by their Roth IRAs. The people then transfer business assets to their shell company and thus into the Roth IRA. For example, a business owned by the person could sell its receivables for less than fair value to the shell corporation. This would shift income away from the individual's business, where it is taxable, into the Roth IRA, where it isn't.
"In effect, this is a disguised contribution to the Roth IRA and the [IRS] notice makes clear that it will be treated as such," Treasury's Assistant Secretary for Tax Policy Pamela F. Olson said in a statement. "The notice illustrates that a contribution to an IRA through a transaction that disguises the value of the contribution may disqualify the IRA" from favorable tax treatment and trigger penalties.
Wondering where you'd stand if Virginia's Gov. Mark R. Warner (D) manages to get his tax package through the legislature? You can try the governor's calculator at taxreform.governor.virginia.gov/index.cfm. But remember whose calculator it is. For one thing, it compares the taxes you pay now with what you'd pay in 2006, when his plan would be fully implemented. It doesn't compare what you'd pay in 2006 under his plan with what you'd pay in 2006 under present law. Thus, a 61-year-old may see "savings," which upon closer inspection would turn out to be the result of qualifying for a $6,000 "age deduction" in 2006, which he wouldn't get in 2003. However, the calculator doesn't mention that under present law the deduction he'd get in 2006 would be $12,000 and his savings would be larger.
