Online Extra: Retirement Plans: The Latest Wrinkles

Here's a roundup of the new options and increased contribution limits that tomorrow's retirees need to consider today

If you've put off setting up a retirement plan for your business, this could be a good time to consider the advantages. Retirement plans are a powerful incentive to attract and retain employees, not to mention a benefit you'll want for yourself.

At present, only about 35% of small companies with less than 500 employees have 401(k) plans. That figure, however, is expected to increase to 65% in five years, thanks in large part to the growing availability of cheaper and simpler 401(k) plans offered over the Web, according to TowerGroup, a financial services research group in Needham, Mass.

There's another good reason to re-think retirement plans, too. As part of the tax cuts that became effective on June 7, numerous changes were made in the law governing 401(k) plans. Most of the changes will be welcomed by your employees, but there are also new ways for entrepreneurs to benefit from a 401(k), says Kyle Brown, retirement counsel at Watson Wyatt Worldwide, a global human-resource consulting firm based in Washington D.C.

Here are the key changes in the law and Brown's take on how they will affect you and your employees.

Tax credits. To encourage small businesses with less than 100 employees to set up retirement plans, they can now get a tax credit for starting a new pension plan or 401k plan. The credit, up to $500 for administrative expenses, is available in each of the plan's first three years.

Increased benefit and contribution limits. High-income participants will welcome an increase in the maximum benefit payable to retirees. Current law limits annual withdrawals to 100% of the beneficiary's former salary, or up to $140,000. This has been increased to $160,000. Contribution limits also have been raised. In defined contribution plans other than 401(k)s, the current limit on employee contributions is 25% of pay or $35,000 per year, whichever is less. This has been increased to 100% of pay, up to a maximum of $40,000.

For 401(k) plans, an employee's annual maximum contribution is currently $10,500. Under the new law, that ceiling rises to $11,000 in 2002, and then by additional increments of $1000 each year until it reaches $15,000. Subsequent increases will be indexed to inflation.

Faster vesting of matching contributions. Currently, matching funds in all retirement plans must fully vest in five years. Under the new law, contributions must be fully vested in three years. "This one won't affect too many small businesses," says Brown, "because small business tend to have immediate vesting...because there are so few employees."

401(k) catch-up contributions for older employees. Under this new provision, plan participants 50 years or older can defer an additional amount to their plans -- $1,000 next year, plus an additional $1,000 a year for the next four years up to a maximum of $5,000.

Although this increased deferral is expected to be very popular among aging employees, it may not sit as well with small companies, which will have to deal with the administrative complexities of processing these additional deferrals.

Roth 401(k)s. Two years ago, Congress created Roth IRAs funded with after-tax income that can be withdrawn tax-free after retirement. Now, lawmakers have added a Roth 401(k), which offers essentially the same terms. The Roth accounts are particularly advantageous for people (like successful entrepreneurs) who will retire in higher tax brackets than the ones they were in while making the contributions.

By Naween A. Mangi in New York

Edited by Robin D. Schatz

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