Link to special CCH Tax Briefings on key topics from 2003:
 

• Year-End Tax Legislation Update (Dec. 10)
• Corporate Income Tax and 'Bonus' Depreciation
  (Dec. 4)
• Military Family Tax Relief Act (Nov. 11)
• Jobs and Growth Tax Relief Reconciliation Act of 2003 (May 28)

CCH can assist you with stories, including interviews with CCH subject experts. Also, the CCH Whole Ball of Tax 2004 is available in print. Please contact:
 
Leslie Bonacum
(847) 267-7153
mediahelp@cch.com
 
Neil Allen
(847) 267-2179
allenn@cch.com

Funding Retirement Plans Still Important Despite Reductions in Capital Gains and Dividend Rates, Says CCH

(RIVERWOODS, ILL., January 2004) – While previous tax changes, such as catch-up contributions, have encouraged individuals to fund their retirement plans, the reduction in the capital gains and dividend rates in last year’s tax law changes may cause some to pull back from funding these plans. However, neglecting retirement accounts in order to take advantage of reduced capital gains and dividend rates may not be the best choice over the long-term, according to CCH INCORPORATED (CCH), a leading provider of tax and pension law information and software.

"The lower capital gains and dividend rates don’t apply to gains that are generated within 401(k)s, IRAs or other qualified plans. So when individuals take distributions from these accounts, they will be taxed as ordinary income," said CCH senior pension analyst Nicholas Kaster, JD, author of Saving for the Future: Roth and Traditional IRAs. "In light of this change," he said, "taxpayers may wish to revisit their asset allocation between taxable accounts and these types of tax-favored accounts." However, people should be careful about making long-term retirement plan changes given the fact that the favorable capital gains and dividend rates are set to sunset at the end of 2008.

"Over the long-term, adequately funding your retirement accounts is the single most important thing you can do to ensure you have the resources you need when you retire," said Kaster.

The main options most individuals have are contributing to their employer-sponsored plans, traditional IRAs or Roth IRAs. Each of these choices has different options and restrictions and, for the next few years, each may be funded with tax credits for low-income individuals and additional contributions by older individuals to further help them build their retirement savings.

Employee Contributions to Employer-sponsored Plans

While some individuals may feel contributing to an IRA is easier and comes with fewer restrictions, 401(k) plans do have their advantages.

"401(k) plans let you make a greater amount of tax-favored contributions and employers often match a portion of the investment, which means the employee is able to fund part of their retirement with employer-provided dollars that wouldn’t be available to them otherwise," said Glenn Sulzer, JD, a senior CCH pension law analyst specializing in 401(k) plans. "It’s generally a sound strategy to first contribute to a 401(k) plan, at least up to the highest amount that an employer will match."

For 2004, employees can defer up to $13,000 in 401(k), 403(b) or 457 plans, with the maximum contribution amounts increasing $1,000 each year until 2006, after which contribution limits are subject to cost-of-living increases.

Another advantage of 401(k) plans is that employees can borrow amounts, including employer matching funds, from their accounts. The loan will not be treated as a taxable distribution if, among other requirements (including repayment generally within five years), it does not exceed a specified dollar limit. Basically, the amount of a loan may not exceed the lesser of $50,000 (reduced by any outstanding loans) or the greater of one-half of the present value of the employee’s vested benefit, or $10,000.

In determining an employee’s vested benefit, elective deferrals are treated as totally and immediately vested regardless of the employee’s length of service or whether the employee is employed on a specific date. By contrast, employer matching contributions and nonelective contributions are subject to deferred vesting schedules. There are two vesting schedules plans can choose from. Under the graded two-to-six yearvesting schedule, employees become entitled to 20 percent of the employer contributions after two years of service, 40 percent after three years, 60 percent after four years, 80 percent after five years and 100 percent after six years. Under a "cliff" vesting schedule, participants become 100-percent vested after three years.

For employees who have a hard time saving, 401(k) plans also offer an advantage as money is taken out of their paychecks before they see it.

The IRA Trio – Non-deductible, Deductible and Roth IRAs

The benefit of a traditional deductible IRA is that it allows taxpayers to make tax deductible contributions to their retirement account, lowering their immediate tax obligation. However, distributions are subject to tax when withdrawn and individuals are required to begin taking distributions when they reach age 70½.

Additionally, contributions are limited to just $3,000 in 2003 and 2004 (rising to $4,000 in 2005). The contribution limit is the lesser of 100 percent of compensation or $3,000.

If an individual is not an active participant in an employer-provided plan, he or she is entitled to take a full deduction for the IRA contribution. If an individual is an active participant, the individual may be able to take a full or partial deduction, or no deduction at all, depending upon filing status and income. In order to fully deduct an IRA contribution in 2004, a single-filer active participant’s adjusted gross income (AGI) must be less than $45,000, with the deduction phasing out completely at $55,000. In the case of married taxpayers filing jointly, the couple’s AGI must be less than $65,000, phasing out at $75,000. The maximum deductible IRA contribution for an individual who is not an active participant, but whose spouse is, is phased out at adjusted gross incomes between $150,000 and $160,000.

While contributions to Roth IRAs are not deductible, all proceeds, including earnings, can be withdrawn tax-free. Eligibility to make contributions to a Roth IRA depends on the income of the individual. The maximum annual Roth IRA contribution is phased out for single taxpayers with AGI between $95,000 and $110,000. For married people filing jointly, the comparable figures are $150,000 and $160,000. Individuals can fund a Roth IRA regardless of whether they’re active participants in an employer-sponsored plan.

For those who qualify for both a traditional deductible IRA and a Roth IRA, choosing which to participate in can be difficult.

"To decide between a deductible and a Roth IRA, you have to be willing to make some assumptions about the future because you don’t know specifics about how much money you’ll earn in the account or what the tax rates will be at the time you take distributions," said Kaster.

For those who know they won’t need to rely on distributions from their IRAs in retirement, the Roth IRA can serve as an effective estate planning tool.

"Because contributors aren’t required to take distributions from their Roth IRAs, they can be passed on intact to heirs, including young children. A child would be required to take distributions over his or her life, but given a child’s long life expectancy, the distributions would be small and the money within the Roth IRA would continue to grow tax-deferred," said Kaster.

Those who do not qualify for a deductible IRA or Roth IRA can contribute to a traditional nondeductible IRA, up to $3,000 in 2004. Unlike deductible IRAs, the portion of the distribution attributable to contributions can be withdrawn tax-free and the portion attributable to earnings is subject to tax.

"Nondeductible traditional IRAs are the last choice and really should only be considered by those individuals who aren’t eligible to contribute to other types of IRAs," said Kaster.

2004, CCH INCORPORATED

Catching Up and Using the Saver’s Credit

For the next several years, employees nearing retirement and those employees in lower income brackets are eligible to accelerate saving for retirement. Individuals 50 years old and older can make "catch-up" contributions to employer-sponsored plans or to IRAs in addition to regular contributions.

As with many other provisions in Economic Growth and Tax Relief Reconciliation Act of 2001, the catch-up contributions are set to expire after 2010 unless extended by further legislation. Available through 2006 are incentives for lower-income workers to add to their retirement savings under the saver’s credit. The saver’s credit will allow eligible individuals to take a tax credit of up to 50 percent of the amount of their contributions to employer plans or IRAs, based on income and filing status. The saver’s credit applies to the first $2,000 of contributions, for a maximum credit of $1,000.The credit is completely phased out at AGI levels of $50,000 for joint filers, $37,500 for head of household filers, and $25,000 for salaried and married filing separately taxpayers.

While helpful to some low-income individuals, there are several limitations to the credit. For example, distributions will reduce the amount of the available credit. The effectiveness of the credit isfurther limited by the fact that it is nonrefundable and, while it can reduce a participant’s tax burden to zero, it can’t reduce it any lower. Thus, the credit does not entitle an individual to an income tax refund.

About CCH INCORPORATED

CCH INCORPORATED, headquartered in Riverwoods, Ill., was founded in 1913 and has served more than four generations of business professionals and their clients. The company produces more than 700 electronic and print products for the tax, accounting, legal, securities and small business markets. CCH is a Wolters Kluwer company. The CCH Federal and State Tax group, CCH Tax Compliance and Aspen Publishers Tax and Accounting group comprise the new Wolters Kluwer Tax and Accounting unit. The unit’s web site can be accessed at tax.cchgroup.com.

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