What Has Changed:

Individuals who participate in tax favored retirement plans at work and self-employed individuals with retirement plans may soon be eligible for greater benefits. Plan contribution, benefit, and deduction limits are going up, generally starting with the 2002 tax year unless otherwise noted.

• Annual additions to a participant's profit sharing or 401(k) plan account -including employee and employer contributions, plus allocated forfeitures -may be as high as $40,000 (or 100% of compensation, if less), up from $35,000/25% of compensation.
  
  
• A benefit of as much as $160,000 (or 100% of average compensation, if less) may be provided for a participant in a defined benefit pension plan for years ending after December 31,2001, up from $140,000/100% of compensation.
  
  
• Plans may take as much as $200,000 of a participant's compensation into account when applying these limits, up from $170,000.
  
  
• An employer's tax deduction limit for contributions to profit sharing and stock bonus plans increases from 15% to25% of the total compensation of covered employees.
  
  
• Dollar limits on employee salary deferrals to plans that allow pretax contributions are increasing in steps from 2002 through 2006, as shown in the accompanying table.
  
  

• 401(k) & SIMPLE Plans Year 401(K) Simple 2002 $11,000 $7,000 2003 $12,000 $8,000 2004 $13,000 $9,000 2005 $14,000 $10,000 2006 $15,000 $10,000

  Participants age 50 and older who have made the maximum deferral allowed under their 401 (k), 403(b), salary reduction SEP, or 457 plan will have an opportunity to contribute an additional "catch-up" amount: $1,000 in 2002, $2,000 in 2003, $3,000 in 2004, $4,000 in 2005, and $5,000 in 2006 and subsequent years. The maximum catch-up amounts for SIMPLE plans are half these amounts.

In another development that may prove attractive, employers will have the option of adding a Roth contribution program to their 401(k) or 403(b) plans, starting with the 2006 tax year. This feature would give employees an opportunity to have all or part of their salary deferral contributions treated like Roth IRA contributions -includable in income in the year contributed but tax free upon distribution, assuming applicable requirements are met.

As early as 2003, employers also will have the ability to add a "deemed IRA" feature to a tax-qualified 401(k), profit sharing, or money purchase pension plan; a 403(b) tax- sheltered annuity arrangement; or a 457 plan. This feature would allow employees to make voluntary contributions to a separate plan account or annuity that meets the requirements of a traditional or Roth IRA.

The Impact:

The more generous contribution, benefit, and deduction limits are good news for highly paid employees and business owners. With these restrictions somewhat eased, employers may be willing to put more money into existing retirement plans or establish new ones. Self-employed individuals also will have an opportunity to shelter more money in tax-deferred plans. The $30,000 increase in the compensation cap (from $170,000 to $200,000) will benefit higher earners, as will the new catch-up contributions and the increases in the elective deferral dollar limits.

Individuals whose employers choose to sponsor a 401(k) or 403(b) plan with a Roth contribution program after 2005 will have a new planning option that could provide personal tax benefits and ultimately benefit their children, grandchildren, or other beneficiaries. Although Roth contributions must be made with after-tax dollars, the ability to earn tax-free investment returns and the fact that there are no lifetime minimum distribution rules are benefits not available with many other retirement plans.

Strategies To Consider:

The new retirement plan rules represent a real opportunity to shelter more of your earnings and/or your investment income from current income taxes. Your strategy for maximizing this opportunity will depend upon the type of plan available to you and your age.

Review Existing Plans and Consider New Ones. If you are self-employed as a sole proprietor or are a partner, major shareholder, or limited liability company member, be sure to talk to a benefits professional about the new law and how you can take advantage of it in your specific situation. If your business already sponsors a plan, you will want to consult with your benefits professional soon about amending your plan to reflect the new tax law and about any changes in plan design that may be beneficial to you and your employees.

Maximize Contributions If you are an employee who is eligible to participate in a contributory plan (such as a 40l(k) plan), you should strongly consider contributing the most your plan allows each year. And note that the new law places no income restrictions on contributions to a Roth contribution 401(k) or 403(b) arrangement, so if you become eligible for this type of plan in the future, you will be able to contribute regardless of your income. Your contributions to a Roth IRA established individually would be subject to potential income-based restrictions. Note also that the age 50 or older catch-up contributions allowed in 2002 and after are not subject to the tax law's contribution limits or nondiscrimination rules.