EGTRRA turns 20 – Opportunities for more retirement savings
By Marcia Mantell, RMA
On June 7, 2001, President George W. Bush signed one of the most influential tax cuts and retirement savings bills. The Economic Growth and Tax Relief Reconciliation Act of 2001 — known as EGTRRA (egg-tra) — clearly recognized a change that was well underway. Namely, that the baby boomers and the younger generations were going to be entirely responsible for financing their own retirement.
And, they faced an uphill battle as longer life expectancy became a reality.
Workers needed more opportunities to save more for retirement. And, at the end of the recession of 2000-2001, the essential was brought to light. It was time to expand tax-efficient retirement savings, especially for older workers who were much closer to retirement.
EGTRRA provisions – An overview
With headlines touting tax cuts and the repeal of inheritance tax as the main provisions, EGTRRA has proposed sweeping changes on many fronts. Tax cuts and tax deduction opportunities have taken many different forms. Overall, this law offered workers and retirees:
· Reduced tax rates from 39.6% to 35%, 36% to 33%, 31% to 28% and 28% to 25%; plus, a new rate of 10%
Taxes on inheritance and transfers by generation leap progressively abolished at 0% in 2010
Elimination of the phase-out of itemized deductions for those earning over $ 100,000
Increase in tax deductions for education costs and savings
Doubling the child tax credit to $ 1,000
Made the income tax credit more generous
Provided alternative minimum tax relief
In addition, EGTRRA ushered in two powerful changes for retirement savings:
· Increased tax deductible contributions to IRAs, 401 (k), 403 (b) and small business retirement accounts; and
Introduces the catch-up provisions for 50 years and over
Increase in tax-advantaged savings allowed in employer plans
Thinking back to the contribution limits for 401 (k) / 403 (b) plans and IRAs, we see decades of lost savings opportunities. Contribution limits were severely reduced in 1986 on the new 401 (k) plans – from $ 30,000 in annual contributions to just $ 7,000 due to the tax revenue required at the time. The limit only increased gradually over the next 16 years.
The new EGTRRA rules increased the savings contribution limits by $ 1,000 per year from 2002 to 2005, reaching $ 15,000, and then the increases will be indexed to inflation.
In addition, the total allowable contribution limit between individual and employer contributions has escaped the $ 30,000 limit in place since 1982. Increases are generally annual, increasing in increments of $ 1,000 linked to inflation. This year, the total combined limit is $ 58,000.
IRA Contribution Limits – Static For Two Decades
We tend to focus on employer-sponsored plans as an effective way to save for retirement. But, only about 50% of all American workers have access to these plans. This makes the IRA incredibly important to the millions of workers without tax-advantaged savings opportunities at work.
When it was introduced in 1974, the IRA limit was $ 1,500 for people with earned income. Eight years later, in 1982, the limit was increased to $ 2,000 and was stuck for the next 20 years.
EGTRRA increased the IRA contribution limits starting in 2002, setting the annual limit at $ 3,000, reaching $ 5,000 in 2008. After that, the increases were linked to inflation. That’s why today’s contribution limit is $ 6,000.
Catch-up contributions designed to help those closest to retirement
Allowing older workers to save more is an interesting concept. The 107e Congress recognized the pending issue for those closest to retirement. They did not have enough opportunities to save in tax-efficient accounts during the 30 years they would spend in retirement.
This earlier 20-year period with little or no increase in savings put a whole generation of retirees at a disadvantage.
And so, catch-up provisions were introduced. For those who turned 50 (or older) as of 2002, they could contribute $ 500 more into an IRA and $ 1,000 more into a 401 (k) or 403 (b). In addition, the 401 (k) catch would increase by $ 1,000 each year to $ 5,000 and then increase with inflation.
It was a remarkably creative way to address the vastly underfunded retirements of tens of millions of Americans. And, with a 15-year window to save more, many baby boomers would have the opportunity to consolidate their personal finances.
Now, 20 years after EGTRRA was enacted, did the catch-up clause do what it was supposed to do?
The catch-up provision hasn’t exactly caught on
Since the 2008 recession, the average 401 (k) account balance has certainly increased. Those who are older have even higher balances. This bodes well for more secure retirement funding.
But the catch-up mechanism does not seem to play such an important role in the savings strategy. There is little comprehensive data on catch-up contributions, but according to most industry and registrar reports, few participants are contributing to their plans, let alone to IRAs.
And, unsurprisingly, it’s high-income workers and those with significantly higher balances in their plan accounts who are making catch-up contributions.
In order for the EGTRRA provisions to work for you, it is important to use both the increased contribution limits and the catch-up provisions to your best advantage. Securing your own retirement income is a top priority. And, every little extra contribution to your IRA and employer plans makes a difference.
The value of catch-up contributions
Anyone who turned 50 in 2002 and started using catch-up contributions has made a significant difference in their retirement pot of gold. Assume that the first 401 (k) eligible retired in 2018 at age 66. Looking only at their catch-up money, they would have an additional $ 134,000 saved for retirement (assuming maximum catch-up contributions from 2002 to 2005, then $ 5,000 in annual catch-up contributions from 2006 to 2018. The rate of return average is 7%.).
Now, consider that they won’t need to dip into this money in the first year of retirement. In fact, with a 30-year retirement prospect, they can continue to keep that money invested for another 15 years. If they get an average return of 5.5%, their catch-up money becomes a whopping $ 305,000. It’s a good portfolio to start the last half of their retirement years.
But let’s be serious… who really has $ 5,000 to withdraw from their cash flow each year from age 50 through retirement? There is no rule that says you must contribute the maximum. Just making smaller catch-up contributions always has a positive impact on your retirement savings.
Can you find $ 100 per month to save $ 50-67? At an average return of 7%, you’ll have almost $ 44,000 more for retirement. Leave it invested for the next 15 years at 5.5%, and you will be celebrating your 82sd anniversary with an additional $ 100,000.
If you can set aside $ 200 per month from 50 to 67 (using the same assumptions), your 82sd anniversary comes with almost $ 200,000.
Take advantage of EGTRRA provisions
The importance of the dramatically improved savings limits introduced under EGTRRA should really be celebrated. Every Baby Boomer, Generation X and even Generation Y have many more opportunities to save for their retirement with EGTRRA.
Here are some ways you can continue to find more money to save and invest for your golden years:
1 – Benefit from the higher limits of your employer plan if you have one. Increase your contributions by 1% per year up to the maximums.
2 – Start an IRA if you don’t already have one. Move $ 50 per month through auto pay to start this account.
3 – Once you reach age 50, get started with catch-up contributions to your employer plan and IRA. Take proactive steps to increase your remedial contributions.
4 – The year you turn 55, you can also add more to your health savings account. An additional $ 1,000 can be paid to your HSA as catch-up dollars.
5 – Think of your catch-up dollars as retirement income at age 80. Start saving at age 50, keep investing until age 80.
Here are the retirement enhancements made by EGTRRA. Make sure you take full advantage of it to help build and protect your income and lifestyle throughout retirement.
About the Author: Marcia Mantell, RMA®, NSSA®
Marcia Mantell is the founder and president of Mantell Retirement Advisory, Inc., a retirement consulting company. She develops innovative programs, marketing materials and educational workshops for the financial services industry, advisors and their clients. She is the author of “What’s the Deal with Retirement Planning for Women?”, “What’s the Deal with Social Security for Women?” and blogs on BoomerRetirementBriefs.com.
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