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Tax Law Changes for Qualified Retirement Plans and IRAs

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Limits on Traditional and Roth IRAs

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Prior Law
IRA contribution limit is $2,000 per individual.
New Law
IRA contribution limit increased to $3,000 in 2002 - 2004; $4,000 in 2005 - 2007 and $5,000 in 2008; and then indexed thereafter in $500 increments.

For individuals age 50 or older, the limit increased by $500 in 2002 through 2005; and by $1,000 in 2006 and thereafter.
Education IRA

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Prior Law
Maximum after-tax contribution is $500 per child for qualified higher education. Contribution limit is phased out for single filers with AGI between $95,000 and $110,000 and joint filers with AGI between $150,000 and $160,000.
New Law
Effective in year 2002, contribution limit increased to $2,000 per child for elementary and secondary education expenses. The AGI of joint filers for contribution phase-out is between $190,000 and $220,000. AGI for single filers is unchanged.
Limits on Retirement Plan Contributions and Benefits

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Prior Law
Limits for 2001:
  • 401(a)(17): annual compensation taken into account is limited to $170,000.
  • 402(g): elective deferrals limited to $10,500 per year.
  • 415(b): maximum annual benefits are the lesser of 100 percent of three-year high salary or $140,000 (or less for pre-65 retirees).
  • 415(c): maximum defined contribution plan contribution is the lesser of $35,000 or 25 percent of compensation.
  • 457(b): contribution limit is generally $8,500 per year.
  • SIMPLE: maximum elective deferral is $6,500 per year.
New Law
Beginning in 2002, the Act raises all of the significant dollar limits as follows:
  • 401(a)(17) compensation increased to $200,000; and then indexed in $5,000 increments.
  • 402(g) elective deferral limit to $11,000 in 2002; then increased $1,000 each year until $15,000 in 2006; and then indexed in $500 increments.
  • 415(b) annual benefit limit increased to $160,000 and will no longer have to be reduced for retirement ages 62 through 65. Note that this provision applies to years ending after December 31, 2001.
  • 415(c) contribution limit to $40,000, and then indexed in $1,000 increments.
  • 457 elective deferral limit to $11,000 in 2002, then increased $1,000 each year until $15,000 in 2006; and then indexed in $500 increments.
  • SIMPLE elective deferral limit increased to $7,000 in 2002, then increased $1,000 each year until $10,000 in 2005; and then indexed in $500 increments.
Participant Loans to Small Business Owners

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Prior Law
Generally, plans may make loans to participants. But, prohibited transaction rules prevent sole proprietors, partners and subchapter S corporation shareholders from taking loans.
New Law
The prohibited transaction rules are changed to allow for participant loans to sole proprietors, partners, and subchapter S corporation shareholders.
Top-Heavy Rules

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Prior Law
A plan is generally considered "top heavy" if more than 60 percent of plan assets are held on behalf of "key employees." Key employees generally include officers earning more than half the section 415 defined benefit plan dollar limit ($70,000 in 2001), five percent owners, one percent owners earning more than $150,000, and the 10 employees with the largest ownership interest in the business (as long as they earn more than $30,000). Furthermore, family members of five percent owners are deemed to be key employees under family attribution rules.

In addition, top-heavy plans must meet a special vesting schedule and make minimum contributions to all non-key employees to the extent contributions are made on behalf of key employees.
New Law
A "top-heavy" plan in which more than 60 percent of the contributions or benefits under the plan are provided to "key employees" generally must provide faster vesting to non-key employees. A key employee is defined as any employee who is:
  • an officer earning more than $130,000 for the year,
  • a five-percent owner of the employer,
  • a one-percent owner of the employer earning more than $150,000.
A "key employee" no longer includes one of the 10 employees with the largest ownership interest in the business.

Matching contributions will count toward satisfying the employer's top heavy minimum contribution.

All matching contributions must follow a top-heavy vesting schedule as provided for under current law.
Exclusion of Elective Deferrals from Deduction Limit

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Prior Law
Generally, employer contributions (including employee's elective deferrals) to a qualified plan are deductible, subject to certain limits. For example, elective deferrals are generally not deductible to the extent that, in the aggregate, they exceed 15 percent of total compensation of employees covered by a profit-sharing plan.
New Law
Elective deferrals will no longer be considered employer contributions for purposes of deduction limits.
Repeal of Coordination Requirements for Section 457(b) Plans

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Prior Law
A maximum of $8,500 in deferred compensation may be put away per year in a 457(b) plan. This limit is generally reduced by elective deferrals under other plans, such as 401(k) or 403(b).
New Law
The section 457 limit on deferred compensation will not be reduced by elective deferrals under other types of salary reduction arrangements.
Deduction Limits for Profit-Sharing Plans

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Prior Law
A sponsor of a profit-sharing plan cannot deduct contributions to the plan in excess of 15 percent of covered employees' compensation.
New Law
The deduction limit for profit sharing plans is increased to 25 percent of covered employees' compensation.
Definition of Compensation

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Prior Law
For purposes of the contribution limits under section 415, compensation includes elective deferrals. However, for purposes of the deduction limits under section 404, compensation does not include elective deferrals.
New Law
For purposes of the deduction limits under section 404, the definition of compensation will now include elective deferrals.
Increase in Percentage of Compensation for Defined Contribution Plan

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Prior Law
Under section 415(c), total annual contributions to a defined contribution plan may not exceed the lesser of 25 percent of compensation or $35,000.
New Law
The 25 percent of compensation limit is increased to 100 percent of compensation in 2002, subject to the contribution limit for the year.
Catch-up Contributions for Older Workers

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Prior Law
The IRS limits the elective deferral to $10,500 per year. There are no separate limits for older workers.
New Law
Beginning in 2002, individuals who are age 50 or older will be allowed to make an additional contribution to a 401(k), 403(b) or 457 plan equal to $1,000 in 2002, then increased by $1,000 each year until $5,000 in 2006. The catch-up amount for SIMPLE plans will be one half of these amounts.

The amount of the catch-up contribution will not be subject to nondiscrimination testing, provided all participating employees over age 50 are eligible to make a catch-up contribution. Also, the catch-up contribution will not count against the employer's deduction limit under Section 404, or against the individual's overall 415(c) dollar limit.
Tax Credits for Lower Income Savers

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Prior Law
No tax credit for low and moderate income savers.
New Law
Eligible persons will receive a non-refundable tax credit of up to 50 percent on up to $2,000 in contributions to an IRA, 401(k), 403(b), SIMPLE or 457 plan. This credit is in addition to the tax deduction already associated with these contributions.

Joint filers whose adjustable gross income is less than $30,000 are eligible for a 50 percent credit. Joint filers with adjusted gross income between $30,000 and $32,500 are eligible for a 20 percent credit. Joint filers with adjusted gross income between $32,500 and $50,000 are eligible for a 10 percent credit. The income threshold for single filers is one-half the threshold for joint filers.

This provision is effective in 2002, and will expire in 2006.
Tax Credits for New Small Employer Plans

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Prior Law
An employer's costs related to the establishment and maintenance of a retirement plan generally are deductible as business expenses. However, there is no tax credit for such expenses.
New Law
Beginning in 2002, small businesses with 100 employees or less will be eligible for an annual tax credit of 50 percent on up to $1,000 of administrative costs for the first three years of a new plan. The credit is available only if at least one non-highly compensated employee is participating.
Changes to 72(t) Payout Rules

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Prior Law
Payments made before age 59½ are not subject to the 10 percent premature distribution penalty if they are made under one of the three IRS-prescribed methods: (1) the minimum distribution method, (2) the annuitization method, and (3) the amortization method. The payments under the minimum distribution method change every year due to the balance of the account and the remaining life expectancy of the individual. However, the payments under the other two methods are fixed until the later of five years or the individual's attainment of age 59½. If the payments under these two methods are modified before the five-year/59½ rule, the IRS imposes a penalty on the payments previously received.
New Law
The IRS has announced changes to the rules for individuals receiving 72(t) payouts from IRAs, qualified plans and tax shelter annuities. The new rules will permit investors who have experienced losses in the stock market to make changes that will reduce their payout arrangements, so that their retirement accounts are less likely to be prematurely depleted by fixed payout requirements.
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