Tax Tips
Economic Growth and Tax Relief Reconciliation Act of 2002 - Part II - January 2002
Richard Scrivanich - Partner
In this month's Tax Tips, we'll continue on with our analysis of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and specifically look at changes made in the estate and gift tax area as well as the retirement savings area.
Estate and gift tax reduction.
The federal estate, gift, and generation-skipping transfer taxes are gradually reduced over the next ten years, and by 2010 the estate tax will be completely eliminated. A word of caution, however; because of certain federal budget laws, these new provisions, if not renewed, may expire and the old rules, rates, and exemptions may come back in 2011. For now, the phase-out schedule is as follows:
| Year |
Top Estate Tax Rate |
Exemption Amount |
|
| |
|
|
|
| 2002 |
50% |
$1 million |
|
| 2003 |
49% |
$1 million |
|
| 2004 |
48% |
$1.5 million |
|
| 2005 |
47% |
$1.5 million |
|
| 2006 |
46% |
$2 million |
|
| 2007 |
45% |
$2 million |
|
| 2008 |
45% |
$2 million |
|
| 2009 |
45% |
$3.5 million |
|
| 2010 |
repealed |
all |
|
For planning purposes, this means that beginning in 2002, the top gift, estate and generation-skipping tax is reduced from 55% to 50%.
Exemption amount.
The amount that is exempt from gift and estate taxes increases in 2002 from $675,000 to $1,000,000.
Unified exemption.
Starting in 2002, a unified exemption will replace the current unified credit. Furthermore, the generation-skipping transfer tax rate will be pegged to the highest estate tax.
State death tax credit.
In 2002, the state death tax credit that offsets the federal estate tax, will be reduced by 25% of the previously allowed amount.
Start planning now.
Whether or not the new law is renewed in 2010, you should take advantage of the increased amount exempt from gift tax. This new $1,000,000 amount starts in 2002. Strongly consider using this exemption if your estate will be greater than the exemption amounts listed previously. This will allow you to increase the amount of after-tax assets passing outside the estate to your beneficiaries if the estate tax repeal is not extended.
Furthermore, the new exemption limit allows those persons who have already used the existing $675,000 exemption amount to make an additional $325,000 of tax-free gifts. If you have not used the exemption yet, you should consider using it in the near future.
Also, you may also want to have the appropriate portions of your will reviewed and revised to ensure that it maximizes the benefits of the new tax laws, and is not hurt by any of the changes.
Retirement savings.
People who recognize the importance of saving for retirement should find a lot to like in the new tax law. It increases overall contribution amounts to 401(k)s and other types of retirement plans, and it even helps those who are 50 or older who need to make up for lost time. Most of these increased contribution limits take effect on January 1, 2002 (and continue to rise for several years thereafter), so now is a good time to review the changes, and plan what steps you need to take full advantage of the contribution amounts.
IRAs.
IRA contribution limits for both traditional and Roth IRAs will increase from a $2,000 annual cap to $5,000 by 2008. For 2002-2004, the contribution amount is $3,000.
To address a general concern that baby boomers haven't saved enough for retirement, starting next year, individuals 50 years of age or older can make tax-free "catch-up contributions" to their IRAs. If you're age 50 or older, you can contribute an extra $500 in 2002 through 2005, and an extra $1,000 in 2006 and beyond.
401(k)s.
Salary reduction contributions to 401(k)-type plans (including 403(b) plans and SEPs) will increase from $10,500 to $15,000 by 2006. In 2002 the contribution limit increases to $11,000, and will increase by $1,000 each year until 2006. After that, the annual limit may rise with inflation in increments of $500 per year. Catch-up rules for employer-sponsored plans allow participants age 50 and above to contribute an additional $1,000 in 2002, rising to an additional $5,000 in 2006.
Defined contribution plans.
Effective for tax years beginning after 2001, the dollar limit on annual contributions to a defined contribution plan will increase to $40,000.
Defined benefit plans.
The annual limit on benefits under a defined benefit plan will go up to $160,000, for taxable years ending after 2001.
SIMPLE plans.
The limit on maximum annual elective deferrals to a SIMPLE plan will increase to $10,000 by 2005. After 2005, the dollar limit will be adjusted annually for inflation in $500 increments. For 2002, the applicable dollar amount is $7,000.
Tax credits.
The legislation also gives lower-income workers a tax credit, instead of a tax deduction, for contributions made to a retirement savings account or plan for years 2002-2006. Joint filers earning less than $30,000 will be entitled to the maximum 50% credit, which phases out completely for those with AGI over:
- $50,000 if married filing jointly,
- $25,000 if single, and
- $37,500 if head of household.
New vesting rules.
Starting in 2002, employer-matching contributions to 401(k) plans must fully vest after three years down from five years under previous law.
Alternatively, the company can start gradual vesting beginning with the employee's second year of service, with full vesting after six years of service, down from seven. Lawmakers are hoping that the shorter vesting periods will encourage greater participation by employees who don't expect to remain with a company for more than a few years.
New rollover rules.
Beginning in 2002, the new law allows workers who switch from the public to the private sector, or vice versa, to roll their retirement savings over into another type of plan. For example, former nonprofit employees with 403(b) plans who now work in the private sector, can transfer their 403(b) balances into their new employers' 401(k) plans. In addition, EGTRRA should make it easier to roll over money that was originally contributed to an IRA into an employer-sponsored plan such as a 401(k), 403(b), or 457 plan. However, keep in mind that the tax law does not require plans to accept rollovers.
In next month's Tax Tips we'll take one more look at provisions enacted by EGTRRA which become effective in 2002. In the meantime, if you have any questions concerning the new tax act, please feel free to give me a call at (562) 698-9891.
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relate only to the year for which the article was written and could be different
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