Originally created 07/29/01

Retirement plans to change



When President Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001, the law gave every working American a tax cut for the first time in 20 years.

"It's been that long since we've had a reduction that affects everyone from the person making $10,000 a year to Donald Trump," said Karen Stinson, an enrolled agent for H&R Block Premium in Augusta.

But while just about everyone will get some money back in the form of the much-ballyhooed rebate checks, ranging from $300 to $600, the bulk of the relief is to be phased in over the next 10 years.

Because of the shifting political winds on Capitol Hill, it's unclear whether much of this legislation will still exist four years from now - much less throughout the decade it will take to phase in all the cuts.

A $1.35 trillion tax-relief package sounds impressive, but what does it really mean? What significance does it hold for the Augusta factory worker, the Aiken schoolteacher and the Evans soccer mom?

"This bill has got 85 major provisions, 441 changes to the IRS tax code and is 300 pages long," said Tim Cherry, an accountant with Elliot Davis & Co. LLC in Augusta. "It is not tax simplification."

Though convoluted, the tax cut has some practical applications for people saving for education and retirement. Four of the five federal tax brackets will be lowered in the next year, but there's no telling how much of this back-loaded tax plan will become reality.

So here's what $1.35 trillion really looks like:

General tax breaks

THE REBATES: The new law lowers the 15 percent tax rate on everyone's initial earnings. The first $12,000 of taxable income earned by all joint filers, the first $10,000 for heads of household and the first $6,000 for singles is now taxed at 10 percent.

The cut will save filers up to $600, $500 and $300, respectively. This year's savings, based on your taxable income during 2000, will be distributed in the form of a refund check by mid-October.

"This is an advance on next year's refund," said Kanchan Khosla, general manager for Jackson Hewitt Tax Service in Augusta. "Everyone would have received this next tax season, but they will get them early because the economy is slow and people hope this will pump it up."

By 2008, the 10 percent tax rate will apply to the first $7,000 of taxable income for single filers and the first $14,000 for couples filing jointly.

RATE REDUCTIONS: An across-the-board rate reduction of 1 percent took effect July 1. Because the cut took effect at midyear, the lower rates for 2001 apply to half the year's taxable earnings, making the average rate cut 0.5 percent.

The 1 percent rate cut will be in effect through 2003. Rates will drop another percent in 2004. In 2006, the three lower brackets will fall another percent, and the highest bracket will be reduced from 37.6 percent to 35 percent.

THE MARRIAGE PENALTY: "The issue we had with two earners who were married is they ended up paying a larger tax than two income earners cohabitating," Mr. Cherry said.

If an unmarried couple making $75,000 file separately, the first $27,050 for each - or $54,100 - is taxed at 15 percent. In the case of a married couple with the same earnings filing jointly, $43,000 is taxed at 15 percent.

By way of easing this penalty, the joint standard deduction for married couples will gradually be raised until it equals twice the single standard deduction in 2009.

ITEMIZED DEDUCTIONS: The Itemized Deduction Limitation and the Personal Exemption Phase Out, under which taxpayers above a certain income level lose their deductions, will be reduced and eventually eliminated.

That helps taxpayers with high incomes, who are more likely to itemize. Eliminating these regulations increases the amount of deductions people are able to claim by itemizing. Once again, however, they won't be completely phased out until 2009.

THE ALTERNATIVE MINIMUM TAX: The Child Tax Credit and the Adoption Credit are now permanently allowed against the Alternative Minimum Tax, increasing the number of items that can be deducted.

The Alternative Minimum Tax is paid by certain taxpayers in lieu of regular federal taxes. The AMT is a parallel tax system that allows different deductions and exemptions.

The AMT exemption amount for married taxpayers was raised $4,000 to $49,000 and that of single taxpayers was raised $2,000 to $35,750.

Relief for parents

CHILD TAX CREDIT: Last year, this credit was $500 per child under age 18. It was increased to $600 this year and will gradually rise to $1,000 in 2010.

For 2001-2004, the credit is refundable to the extent of 10 percent of a taxpayer's income.

CHILD- AND DEPENDENT-CARE CREDIT: Beginning in 2003, eligible expenses for this child-care credit increase to maximums of $3,000 for one child and $6,000 for multiple children.

Parents can now be credited for up to 35 percent of eligible expenses. The credit is reduced by 1 percent for each $2,000 that the average gross income exceeds $15,000, up from $10,000.

Education relief

EDUCATION IRAs: The maximum contribution for Education IRAs rises from $500 to $2,000. Income limitations are up as well, as couples earning as much as $220,000 annually can open accounts.

Under the previous law, couples earning up to $150,000 could fully fund an Education IRA. The contribution gradually decreased until it was phased out entirely when the couple's income reached $160,000. The new phase-out range has been increased to $190,000-$220,000.

Funds might also be used for elementary and secondary school tuition and supplies as well as for college.

STUDENT LOAN INTEREST DEDUCTION: This cut applies to student-loan payments made in 2002 and after. The phase-out range for single filers increases from $40,000-$50,000 to $50,000-$65,000, while joint filers' limitations increase from $60,000-$75,000 to $100,000-$130,000.

EMPLOYER-PROVIDED EDUCATION ASSISTANCE: A $5,250 tax break is permanent, as of this year. Education paid for by an employer is no longer considered taxable income to the employee who benefits and is deductible to the employer. In 2002, graduate-level courses are also eligible.

PREPAID TUITION: As of 2002, state 529 College Savings Plans are no longer subject to federal taxes. The legislation will be effective for private colleges by 2004.

Retirement

"This legislation represents the most significant change in pension law in more than two decades," said Buzz Hankinson, a certified financial planner with Hankinson Retirement and Investment Specialists Inc. in Augusta.

Beyond raising contribution limits and expanding retirement plans, the new tax law makes IRAs, 401(k)s, 403(b)s and 457s more flexible. By 2002, a 457 can be rolled over into an IRA. This year the minimum distribution requirement for IRAs was lowered, allowing retirees to keep more money working for them in their accounts and making IRAs last longer.

"People can let their money sit there and make more money," Mr. Hankinson said. "Retirement distribution planning is going to change."

INCREASED IRA LIMITS: Annual IRA contribution limits will increase three times in the next eight years. The current limit of $2,000 will rise to $3,000 in 2002, $4,000 in 2005 and $5,000 in 2008.

Taxpayers who are 50 and older can play catch-up. They will be allowed to contribute an extra $500 a year between 2002 and 2005 and an extra $1,000 a year afterward, in addition to the general limits listed above.

401(k), 403(b) AND 457 PLANS: Currently, annual contributions to 401(k) and 403(b) plans are limited to $10,500 and 457 plans are limited to $8,500. These caps will gradually increase to $15,000 by 2006 and be indexed for inflation afterward.

Taxpayers older than 50 will again be allowed to play catch-up, able to contribute an extra $1,000 per year.

SIMPLE PLANS: These are for small-businesses employers who want to fund some retirement plan but are not able to use traditional plans because of funding-level requirements. SIMPLE plans have a low administrative cost.

Current annual contribution limitations are at $6,500. The plan is to gradually increase the limit to $10,000 by 2005 and index it for inflation after that.

The death tax

This belongs in a category by itself. Much has been made of how this new law will abolish the estate tax, and it will - sort of.

The plan shaves the maximum estate tax from 55 percent to 45 percent over a period of nine years. The credit, currently at $675,000, jumps to $1 million next year and reaches $3.5 million by 2009. In 2010, the estate tax will be repealed - but only for that year.

These provisions run out at the end of 2010, and the old estate tax of 2001 becomes law again. Unless a future administration makes its repeal permanent, the death tax of 2001 will take effect again in 2011.

"This is not empty legislation - it's worse than that," said Aubrey Rhodes, a partner with the Augusta law firm of Rhodes, Enoch & Taylor. "You can avoid the estate tax by planning, and this law lures people into doing nothing."

Reach John Bankston at (706) 823-3352or jbanks15@hotmail.com.