Tax Legislation Affecting 401(k) Plans

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) increases opportunities for individuals to save for retirement. Many of these opportunities began in 2002 and phase in over a number of years. Below is a list of some of the major changes affecting retirement savings.

Increased 401(k) Contribution Limits

In 2004, the 401(k) contribution limit rose to $13,000 (and will continue to rise, reaching $15,000 by 2006). In addition, the "15% of compensation limit", which, prior to 2002, required companies to limit the contributions of most 401(k) participants so that total contributions company-wide would not exceed 15% of the company’s payroll, was repealed. As a result, instead of limiting employee contributions to any specific percent of pay, companies are able to let their employees contribute any percent of pay, up to the maximum amount specified for that year ($13,000 in 2004). In addition, workers over age 50 are now permitted an additional $3,000 catch-up limit in 2004.

Note about contribution limits for workers earning more than $90,000 and owners.

Note that special contribution limits may apply to employees who earn more than $90,000 a year or who are partial owners. Due to anti-discrimination rules intended to prevent highly compensated employees and owners from disproportionately benefiting from the 401(k) plan, this group of employees may not be permitted to contribute the full $13,000. Contribution limits for this group will vary by company depending upon circumstances such as the participation rate among employees earning less than $90,000.

Schedule of 401(k) contribution limits:

Schedule of IRA contribution limits:

2002:

$11,000

2002:

$3,000

2003:

$12,000

2003:

$3,000

2004:

$13,000

2004:

$3,000

2005:

$14,000

2005:

$4,000

2006:

$15,000

2006:

$4,000

2007:

$4,000

2008:

$5,000

401(k) Catch-Up Contribution for Workers Over Age 50

Employees who turn age age 50 or older within the end of the plan year are permitted to make "catch-up" contributions that exceed the regular 401(k) contribution limits. They can make a catch-up contribution of up to the lessor of: (1) $3,000 in 2004 (for a total limit of $16,000) increased by $1,000 per year up to $5,000 in 2006 (indexed in $500 increments thereafter) or (2) 100% of pay less any other elective deferrals for the year.

Please note that your employer is not required to allow catch-up contributions.

Temporary Tax Credit for Low and Middle Income Savers

A tax credit of up to $1,000 is available to some taxpayers depending on income. Workers eligible for this tax credit are single taxpayers with an adjusted gross income (AGI) of $25,000 or less, taxpayers filing as heads of household with an AGI of $37,500 or less, and taxpayers filing jointly with an AGI of $50,000 or less. The credit equals 10 – 50% for each $1.00 you contribute to your plan or IRA, up to the first $2,000. This tax credit only lasts through 2006 and applies to people age 18 who are not claimed as a dependent by another taxpayer. Note that this tax credit also applies to 401(k) plans, IRAs, 403(b) plans, and 457 plans, with the total tax credit not to exceed $1,000 across all plans.

IRS Announcement 2001-106 on the Saver's Tax Credit (pdf document).

Increased Pension Portability

You now have the opportunity to rollover balances between various types of qualified plans. Rollovers are now permitted between 401(k), 403(b) and 457 plans. Note that it is up to individual employers to decide which types of rollovers they accept. You should consult your employer for specific details about what types of rollovers are permitted.

Faster Vesting

The employer matching contributions to your defined contribution plan(s) is now required to vest as rapidly as: (1) 100% vested after three years; or (2) 20% vested after two years with an additional 20% vested each year until 100% vested at six years.

Decreased Suspension Following Hardship Withdrawal

Participants who take a hardship withdrawal from their plan are now prohibited from making contributions for 6 months, reduced from a 12 month suspension period.