401(k) Plans - New Rules and Regulations

The rules for contributions to one’s 401(k) plan and catch-up contributions have been changed in the Economic Growth and Tax Relief Reconciliation Act.

Maximum Pre-Tax contribution
2002: $11,000
2003: $12,000
2004: $13,000
2005: $14,000
2006: $15,000

Percentage-of-Pay Limits
100% of compensation or $40,000, whichever is less.

(Note: This governs all employer contributions and employee contributions. For example, if an individual earns $36,000 per year, he/she would be able to contribute $11,000. The percentage of pay rule would not apply since the pretax limit was hit first.)

Portability
· Ability to transfer 401(k) funds directly into a new employer’s 401(k), 403(b) or 457 plan if one changes jobs.
· Ability to transfer 401(k) into an IRA.
· Ability to roll IRA pretax contributions and earnings on contributions that have been made into an employer’s plan.

(Note: Employers who would formerly cash out 401(k) balances between $1,000 and $4,999 must roll the funds into an IRA in an individual’s name if one leaves. However, the individual has the choice to take cash.)

Vesting
Cliff vesting means that the entire employer contribution vests, or becomes one’s property, after an individual has worked at the job for certain number of years. This is now a maximum of 3 years. Even if an employer had a vesting schedule of 5 years, an employee would be automatically vested if having had only 4 years of employment with the company due to the 3 year rule.

Graded vesting means a certain amount of the employer’s contribution becomes the property of the employee each year. This is now a maximum of 6 years.

Maximum Includable Compensation Limit
$200,000, and indexed to inflation with adjustments in $5,000 increments

Catch-up Contributions
· Ability to make catch-up contribution if employed by same employer for a minimum of years if savings opportunities were missed in earlier years.

· Ability to make catch-up contribution if over age 50:
2002: $1,000
2003: $2,000
2004: $3,000
2005: $4,000
2006: $5,000

· Employees of government may use 403(b) savings to buy service credits in their pension plans.

After-Tax Saving
· Ability to have payroll deduction directly to Roth 403(b), though not tax-deductible, but tax free at retirement.
· Roth 403(b) has the same percentage of pay limit combined with pretax contributions.

Simple 401(k)
Yearly contribution limit
· 2002: $7,000
· 2003: $8,000
· 2004: $9,000
· 2005: $10,000

Catch-up contributions for over age 50
· 2002: $500
· 2003: $1,000
· 2004: $1,500
· 2005: $2,000
· 2006: $2,500
· 2007 and after: indexed to inflation, increasing in $500 increments