Clients may be asking about the new "catch-up" pension and IRA contributions allowed under the latest tax act. CPAs should be aware of these new provisions to educate themselves and instruct clients properly.
Many employers offer plans in which workers set aside some of their salary for retirement. A "salary reduction" arrangement allows an employee to elect to have the employer pay a portion of salary to an employee plan. These "elective deferrals" are excludable from the employee's income if certain requirements are met.
The maximum annual elective deferral per individual in 2001 in a qualified cash or deferred arrangement (CODA) (IRC section 401(k)), tax-sheltered annuity (section 403(b)) or simplified employee pension (SEP) plan (section 408(k)) is $10,500 (indexed annually for inflation). The 2001 maximum for a savings incentive match plan for employees (SIMPLE) (section 408(p)) is $6,500 (indexed annually for inflation).
Employees of a state (including a political subdivision, agency or instrumentality) or a tax-exempt organization are not deemed to have constructively received compensation deferred under an eligible deferred compensation plan (section 457(a)). For these employees, the 2001 deferral limit is the lesser of $8,500 or 33 1/3% of compensation. Under a special catch-up rule, a section 457 plan can provide that, for one or more of the participant's last three years before retirement, the otherwise applicable limit is increased to the lesser of (1) $15,000 or (2) the sum of the otherwise applicable limit for the year, plus the amount by which the limit in prior participation years exceeded deferrals for that year.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) added section 414(v), raising--for individuals at least age 50 before the end of the plan year--the limits on elective deferrals for section 401(k) qualified CODA plans, 403(b) tax-sheltered annuities, 408(k) SEPs, 408(p) SIMPLEs and 457 state or local government plans.
This provision is particularly intended to aid women nearing retirement age who may be behind in saving for retirement due to career interruptions.
Under the new law, the additional amount of elective contributions is the lesser of the (1) "applicable dollar amount" or (2) participant's compensation for the year, reduced by any other elective deferrals for the year.
The "applicable dollar amount" varies, depending on plan type:
* For plans other than SIMPLE plans under sections 401(k)(11) or 408(p), the applicable dollar amount is $1,000 for 2002, $2,000 for 2003, $3,000 for 2004, $4,000 for 2005 and $5,000 for 2006 and thereafter.
* For section 401(k)(11) or 408(p) SIMPLE plans, the applicable dollar amount is $500 for 2002, $1,000 for 2003, $1,500 for 2004, and $2,000 for 2005. This amount rises to $2,500 for 2006 and thereafter.
Both the $5,000 and $2,500 amounts applicable starting in 2006 will be indexed for inflation starting in 2007 and continue thereafter.
Only "eligible participants" can make these additional contributions, defined as participants who have attained age 50 before the close of the plan year and for whom no other elective deferrals may be made to the plan for the year because of any limit or restriction in section 414(v)(3) (for example, the annual limit on elective deferrals) or any comparable plan limit or restriction. …