Review Your Plan & Its Investments Now

Barbara Weltman Tax law changes may affect the retirement savings plan you use and the investments you keep in it.

The tax law allows you to make larger tax-advantaged contributions than ever before. If your business is profitable and you want to save as much as you can on a tax-favored basis, keep these per-participant limits in mind for 2003:

  • Contributions to profit-sharing plans and SEPs that are fully deductible can run to %25 of compensation, not to exceed a contribution of $40,000. Only compensation up to $200,000 may be taken into account.
  • Contributions to a 401 (k) plan can include salary reduction contributions up to $12,000 ($14,000 for those age 50 or older by December 31, 2003). While salary reduction (elective deferral) contributions are not deductible, you are not immediately taxed on this income. You are not required to make employer contributions, but can opt to do so.
  • Contributions to SIMPLE plans can include salary reduction contributions (elective deferrals) of up to $8,000 ($9,000 for those age 50 or older by December 31, 2003), plus employer contributions of up to 3% of compensation (not to exceed elective deferrals).

Factor in Plan Selection
The type of plan you select depends on many factors, including tax law changes:

  • Your age (and when you expect to retire). If you haven’t saved much to date and retirement is just around the corner, you may want to consider a defined benefit plan, which allows you to target a retirement benefit and then make annual contributions actuarially determined to meet your target (assuming a certain rate of return). If you have many working years ahead of you, other considerations may play a greater role in your choice of plan.
  • The number of employees. The more you have, the greater your costs using a traditional profit sharing plan. You may prefer to shift the cost to employees by opting for an elective deferral plan, such as a 401 (k) or SIMPLE plan.
  • Your earnings. If you make a substantial income, your greatest contribution option may lie with a profit-sharing, SEP or 401 (k) plan. If your income is modest, a SIMPLE plan can maximize your retirement savings.

Review your options with a knowledgeable retirement plan expert to determine the plan that is best for your situation. Don’t delay; you may have to take action now. For example, if you want to adopt a SIMPLE plan for 2003, you must do so no later than October 1, 2003, in order to comply with employee notice requirements. A profit-sharing plan for 2003 must be set up by December 31, 2003, even though contributions can be made as late as the extended due date of your 2003 return.

Investment options
Keep these important tax changes in mind when investing retirement plan contributions:

  • The maximum capital gains tax rates for transactions after may 5, 2003, is 15%.
  • The maximum tax rate on dividends after December 31, 2003, is 15%.

These changes have no direct impact on investments with in a qualified retirement plans. All distributions from such plans are taxed at ordinary income rates up to 35%, regardless of the underlying source of those distributions.

But these changes have an indirect impact:

Short savings horizon. If you’re nearing retirement, you may wish to consider re-balancing your personal savings portfolio and our retirement plan investments so that investments paying ordinary income, such as corporate bonds, real estate investment trusts (REITs) and stocks to be traded for short-term gains are held in qualified plans, while dividend-paying stocks and stock mutual funds are held outside these plans. The ordinary income earned within the plans will be tax deferred until the distributions are taken, while the dividends and capital gains realized on personal investments will enjoy tax-favored rates.

Long savings horizon. If you have many years until retirement, tax deferral (rather than low tax rates), even on capital gains, is the primary benefit to savings. This means that you may wish to keep equities, including dividend-paying stocks and stock mutual funds, within your retirement plans. Reasons: You may be in a low tax bracket when you take distributions…tax rates on capital gains and dividends may not stay at current lows (the 15% rate is set to run only through 2007).

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