BUILD YOUR RETIREMENT SAVINGS...
Higher limits mean that you can tuck away a lot more money
into 401(k)s and other tax-favored retirement plans, even play
catch-up if you're 50 or older. Take advantage.
If you're worried whether you're saving enough for retirement,
there's some good news that might take the edge off.
You can put far more into tax-favored retirement savings plans
these days, thanks to big increases in contribution limits. Contribution
limits to all kinds of retirement plans -- including 401(k)s and
IRAs -- will keep moving up through 2008. After that, the limits
will rise with inflation.
Older workers can save more on top of that with catch-up contributions.
"This is great news for people who feel they are behind
in their savings. They'll be able to make much more headway,"
says Ron Roge, an investment adviser in Bohemia, N.Y.
For years investors and advisers complained that contribution
limits were too low, says Clint Stretch, director of tax legislative
affairs at Deloitte & Touche in Washington, D.C. While 401(k)
limits have risen more or less in tandem with inflation, usually
in $500 increments, IRA limits of $2,000 a year were set in 1981
weren't adjusted until recently.
The New Rules
Here's how the retirement-saving environment has changed:
Individual Retirement Accounts and Roth IRAs. Contribution limits
for regular IRAs and Roth IRAs rose to $4,000 in 2005, up from
$2,000 as recently as 2002. And IRA contribution limits rise once
more in 2008 to $5,000. Plus, there are catch-up provisions that
let workers 50 and older kick in an extra $500 in 2005, and an
extra $1,000 starting in 2006. If you're skeptical about what
difference an extra $1,000 a year in savings can make per person,
take a look at the numbers: If you squirrel away $3,000 each year
for 30 years and earn an average 8% annual return, you'll end
up with $339,849, Roge says. Under the old rules, investing $2,000
a year, you would have accumulated $226,556 in that period.
401(k) and 403(b) accounts. The maximum you can put into these
hugely popular employer-sponsored retirement plans rose in 2005
is $14,000. That limit went up another $1,000 in 2006, and is
now indexed to inflation.
SIMPLE and SEP plans. Investors in SIMPLE plans offered by employers
with fewer than 100 employees can put in more, too. So can self-employed
people, who can invest more in SIMPLE plans or boost their contributions
with a SEP (simplified employee pension IRA).
A bonus if you're 50 or older. The biggest retirement-savings
benefits go to people aged 50 and over. Thanks to so-called catch-up
provisions, they can contribute more to their retirement plans
than most folks. They could invest as much as $18,000 in a 401(k)
in 2005; $14,000 plus a $4,000 catch-up contribution. The catch-up
limit rises to $5,000 for 2006, so those 50 and over can save
up to $20,000 in a 401(k).
To get the most out of these changes, your top priority should
be to invest the maximum in your 401(k) or 403(b) plan, if you
are eligible for one. Contributions in 401(k)s are made with pre-tax
money, and often employers will match a portion of what you put
in. These benefits make a 401(k) too good to pass up.
What's more, the law accelerates the vesting of employers' matching
contributions -- that is, the full rights to an employer's match.
"In the past, company matches had to be fully vested after
five years, or according to a phase-in schedule lasting seven
years," says Bill Arnone, director of employee financial
education at Ernst & Young in New York.
Now, employers must either grant 100% vesting after no more than
three years or adopt this phase-in schedule: 20% after two years,
40% after three years, 60% after four years, 80% after five years
and 100% after six years.
What if you don't have a 401(k)?
If you aren't eligible for a 401(k), your first priority should
be to contribute whatever retirement plan your employer makes
available to you -- a 403(b), SEP or SIMPLE plan.
If you're self-employed, you can invest in an SEP or SIMPLE.
Like the 401(k), these plans allow pre-tax contributions, and
your money grows tax deferred.
So you can pat yourself on the back if you manage to contribute
the maximum to your 401(k) or a similar plan. But don't stop there.
Love that IRA
Once you have maxed out, see if you can't squeeze out some more
savings for an IRA.
Your best bet is to invest in a Roth IRA, because your investments
grow tax-free and you can take the money out tax-free. But there
are income restrictions.
There are two kinds of regular IRAs -- deductible and non-deductible.
In both cases, your money grows tax-deferred. The added benefit
to the deductible IRA is that your contributions are tax-deductible.
If you (and your spouse, if you're married filing jointly) aren't
eligible for another retirement savings plan, you can contribute
to a deductible IRA regardless of income. But if you are eligible
for an employer-sponsored plan, you can lose part or all of your
deduction based on your income.
A non-deductible IRA has no income restrictions.
Even if you can't max out on IRA contributions, sock away what
you can -- and don't wait until the end of the year, says Lisa
Osofsky, a tax adviser at M.R. Weiser & Co. in New York. "That
way you get a head start -- set it aside early and you'll get
the whole year of tax-deferred growth," she says. "As
long as you have the cash to invest, it'd be nuts not to get the
most out of the breaks the government is handing you."