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How New Tax Law Increases Retirement Plan Wealth-Building
$40 billion of additional tax relief is on its way to what is already the largest legitimate tax shelter in the U.S. economy: the tax-favored retirement plan. This relief is in the big 2001 tax cut bill President Bush signed June 7.
Enhancing tax-favored retirement benefits was a major aim of that law--in one sense, the major aim, since more than half of the law's 127 pages deal with retirement plans. If you're a self-employed person without employees, here's what the law has to offer the retirement plans--Keogh plan, SEP, SIMPLE and IRA--that you might adopt.
- Larger deductible contributions to a Keogh "money purchase" type of pension plan--as high as $40,000 a year.
- Larger deductible contributions to a Keogh profit-sharing plan. Deduction can now be as large as with money purchase plans.
- Larger annual retirement benefits under a Keogh "defined benefit" type of pension plan--allowing a pension as high as $160,000 a year. This and other changes allow higher deductible contributions to such plans.
- Larger deductible contributions to SEP (also called SEP IRA) plans--as high as $40,000 a year.
Larger contributions to SIMPLE (SIMPLE IRA) plans--as high as $14,000 in 2002, higher in later years.
- Larger after-tax (nondeductible) contributions to Keogh plans. These are contributions owner-employees make wearing their employee hat.
- A new deductible catch up contribution wearing the employee hat for owner-employees age 50 or over: up to $1,000 in 2002, higher in later years. Available for contributions to Keoghs and SEPs; for SIMPLEs the contribution ceiling is halved (up to $500 in 2002).
- Larger contributions to traditional or Roth IRAs--as high as $3,000 in either case (not more than $3,000 in all if combined) for 2002--2004; higher in later years. Deduction for traditional IRAs tested under current rules; Roth IRA contributions continue nondeductible.
- New catch up contributions to traditional or Roth IRA for persons age 50 and over, up to $500 for 2002--2005, higher thereafter. Deduction determined under current rules. This catch up contribution is in addition to deductible catch up contribution described above (contribution as employee made to Keogh, SEP or SIMPLE plans).
- New tax credit allowed low-income taxpayers for plan contributions, available to self-employed persons for contributions to a SEP or SIMPLE, or Keogh after-tax contribution as employee. A comparable credit is available for contribution to a traditional or Roth IRA. The maximum credit (rarely available) is $1,000.
- Rollovers from IRAs to Keoghs are now allowed and may, within limits, include after-tax contributions.
- Plan loans are eased. Department of Labor approval to borrow from your own plan is no longer required. Loans are now allowed up to $50,000.
When. All these changes became effective in 2002 or, as designated, starting in 2002 and increasing in later years.
So--wait till next year? Not if you have no plan now. A plan you adopt and fund this year can mean big tax savings this year--much bigger than your 2001 tax cut.
For example, with taxable income and self-employment earnings of $80,000 for 2001 (disregarding self-employment tax), the Bush tax cut saves $559 for 2001. If you invest the maximum allowed in a money purchase ($16,000) on your own behalf, you save a further $4,802 in taxes--more than 8 times the Bush tax cut. This $16,000 is your own money, growing tax-free in your own Keogh investment account.
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