House Bill Seeks to Help Workers Build Bigger Nest Eggs
Late savers and employees of small companies could be big winners if a House bill to enhance retirement savings plans becomes law.
The Comprehensive Retirement Security and Pension Reform Act, overwhelmingly approved by the House on Wednesday, would hike contribution limits for individual retirement accounts and 401(k) programs.
Perhaps just as important, the bill would dramatically streamline pension rules for small businesses, making it far easier and less expensive for these firms to offer retirement savings plans to their workers.
The legislation also aims to help late savers catch up by allowing them to make bigger tax-deductible contributions to retirement plans. And it would create a new type of 401(k) plan.
In addition, the bill would speed up pension “vesting” rules, entitling workers to company pension contributions roughly two years faster than under current law.
The Senate is expected to take up the legislation in the fall. Although President Clinton has said he opposes the House bill because of concerns it doesn’t offer enough help for lower-income Americans, the momentum appears to be strong to improve popular retirement savings programs.
Here are some questions and answers about specifics in the House bill:
Question: How would the proposed law help late savers?
Answer: There are two savings “catch-up” provisions in the law. One would affect participants in 401(k) plans; the other would affect contributions to individual retirement accounts. The bottom line on both: If you are age 50 or older, you could sock away considerably more in tax-deferred savings plans than allowed under present law.
Specifically, people 50 or older would be able to make deductible IRA contributions of up to $5,000 annually, starting next year. That would give late savers the ability to squirrel away $3,000 more annually in tax-favored accounts than they can under present law.
People 50 or older who participate in 401(k) plans would get an even greater benefit. Starting next year, they would be able to contribute $5,000 more to their plan each year than would otherwise be allowable. This would complement another provision in the bill raising overall 401(k) contribution limits.
Q: Can higher contribution ceilings make much of a difference for people who have waited until their 50s to start saving for retirement?
A: Yes. The impact can be dramatic. Consider, for example, a 50-year-old man who saves the currently allowable $2,000 annually in an IRA and earns an average of 10% a year on his money, tax-deferred. After 10 years, this individual would have a nest egg of $31,875. After 15 years, he would accumulate $63,545.
However, saving $5,000 annually at a 10% return would produce a nest egg worth $79,687 in 10 years and $158,862 in 15 years.
Q: How would 401(k) plans in general be affected?
A: They would be changed in two ways: Allowable contribution amounts would be boosted more quickly than scheduled under current law, and a new type of Roth-like 401(k) would be created.
Current law adjusts maximum annual 401(k) contributions to inflation. The proposed law would legislate that maximum contribution amounts would rise faster, from about $10,500 now to $11,000 in 2001; $12,000 in 2002, $13,000 in 2003; $14,000 in 2004; and $15,000 in 2005.
Meanwhile, employees would be given the choice of contributing on a pretax basis, as they currently do, or making nondeductible contributions. Like Roth IRA contributions, contributions to a Roth 401(k) wouldn’t reduce your current taxable income. However, the money would grow on a tax-deferred basis and would be tax-free when withdrawn at retirement.
Q: How would employees of small businesses benefit?
A: Although the bulk of big companies offer pensions and retirement savings plans for their workers, that’s not true of small businesses. Only about 20% of the nation’s small employers--those with 25 or fewer workers--offer any type of pension plan. Companies say that’s largely because the plans are so complicated that the cost of administering them can be prohibitive.
Congress has attempted to address this in the past by creating so-called SIMPLE-IRA plans, which require less government reporting and tax-testing. However, the SIMPLE program (it stands for savings incentive match plan for employees) currently requires that small businesses either match worker contributions to set amounts or kick in 3% of each workers’ wages. Small companies have argued they can’t afford that either.
The proposed law would amend the SIMPLE pension program, allowing small companies to set up plans that don’t require employer contributions. These plans would allow workers to annually save up to $5,000 of their own money on a before-tax basis through employee withholding. Although that’s the same amount you’d be able to contribute to an IRA if the proposed law passes, making retirement contributions through a company plan can be more attractive because you get the tax savings as you contribute, rather than later when you file your annual tax return. That also can make contributing to the plan more affordable.
Meanwhile, maximum contributions to traditional SIMPLE plans--the type that include employer contributions--would rise to $10,000 annually under the House bill from the current maximum of $6,000.
Q: How would the act affect tax-deductible IRA contributions?
A: Deductible contribution limits would ratchet up for all taxpayers to $3,000 in 2001; $4,000 in 2002 and $5,000 in 2003. At that point, deductible amounts would be adjusted annually for inflation in increments of $500.
However, income limitations on the deductibility of IRA contributions would still apply to those covered by other qualified pension plans.
This year, married taxpayers begin to lose their ability to deduct IRA contributions once their joint adjusted gross income exceeds $52,000 and phases out completely at $62,000. Single taxpayers earning less than $32,000 can fully deduct IRA contributions. Deductibility is restricted at higher income levels and this year is eliminated completely when single income exceeds $42,000.
Those who aren’t covered by any other qualified pension can deduct IRA contributions regardless of their income. And even people unable to take a tax deduction for an IRA contribution can still contribute to the accounts, to allow savings to grow tax-deferred. That would be true under the new law as well.
Q: What about Roth IRAs? Would you be able to contribute more to these too?
A: Yes. Allowable Roth contributions would rise by the same increments as traditional IRA contributions, as would contributions to nondeductible IRAs.
Q: How would traditional pensions be affected by the House bill?
A: Under current law, companies have two ways to determine when you are fully entitled to receive pension benefits. “Gradual vesting” schedules give you incremental pension credits each year until you are fully vested--that is, 100% entitled to the pension set aside in your name--within seven years. Alternatively, companies can choose so-called “cliff” vesting, which gives no credit in early years but full credit after five years, says Mark Luscombe, principal tax analyst with CCH Inc., a publisher of tax information.
Under the proposed law, vesting schedules would be shortened, allowing employees to fully earn their pension in five years under the gradual vesting formula, and in three years under cliff vesting. (Companies can always allow workers to vest more quickly than the law requires, but not more slowly.)
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Kathy M. Kristof can be reached at kathy.kristof@latimes.com.
