Retirement Savings

What is it?
An Individual Retirement Account, or IRA, is a personal savings plan that offers you tax advantages to set aside money for your retirement or, in some plans, for certain educational expenses.

What's changing?
The tax cut increases contribution limits to your retirement savings and provides catch-up opportunities as well. Starting in 2002, the maximum contribution will rise to $2,500, and reaches $5,000 in 2010. If you're 50 years old or over, you can contribute $500 more than the limit during 2002 through 2005. The tax cut also offers certain taxpayers (below $25,000 income if single or $50,000 if married filing jointly) a nonrefundable credit for contributions to IRA or pension plans.

What does it mean to me?
The bill means a greater opportunity for many middle- and higher-income taxpayers to save through IRAs and 401(k)-type plans and "catch up" opportunities for those 50 and over.

The Details ...

The new law will greatly expand education IRAs beginning in 2002.

In one of the most controversial changes made by the legislation, the new law will allow education IRAs to be used for elementary and secondary-school expenses, including tuition at private and parochial schools. Education IRAs can now be used only to save for a child's college education.

The new law will also increase the annual contribution limit from $500 now to $2,000 in 2002.

Contributions to an education IRA can be made on behalf of a child under age 18. Contributions aren't deductible but withdrawals can be made tax-free if used to pay eligible education expenses.

Income-Eligibility Limits

The new law will also raise the income-eligibility limits for married couples.

The ability to make education IRA contributions now phases out for couples with adjusted gross incomes between $150,000 and $160,000 on a joint return. Under the new law, the phaseout range for couples will be $190,000 to $220,000 starting in 2002.

Multiple Benefits

Beginning in 2002, families who take advantage of education IRAs will no longer be automatically disqualified from also claiming the Hope or Lifetime college tuition credit for a student in some years.

Currently, the tuition credits can't be claimed for a student in those years when money is withdrawn from the student's education IRA.

But the new law will remove the prohibition so long as the education IRA withdrawals aren't used for the same expenses for which the Hope or Lifetime credit is claimed.

Contribution Deadline

The deadline for making annual contributions to education IRAs will be extended.

Instead of having to contribute by Dec. 31 each year, the new law will allow contributions to be made as late as April 15 of the following year. That is the same deadline for contributions to other types of IRAs.

Extending the deadline to April 15 will be of particular help to higher-income families who aren't sure until they fill out their tax returns whether they meet the income-eligibility requirements for the education IRA.

Contentious Issue

Expanding education IRAs was a top priority of Congressional Republican in recent years. Expanding the tax-sheltered accounts to pre-college expenses was part of an effort to advance the conservative cause of "school choice."

Most Democrats strongly opposed expanding education IRAs to include pre-college expenses on grounds that it would effectively provide a federal subsidy for private schools and undermine public school systems.

Eligible Elementary and High School Expenses

The new law will permit education IRA funds to be used for a wide variety of elementary and high school expenses. Included are tuition, fees, academic tutoring, books, supplies, equipment and "special needs services" for special needs students.

Also eligible expenses for kindergarten through 12th grade students are room, board, uniforms, transportation and "supplementary items and services (including extended day programs) which are required or provided by a public, private or religious school in connection with such enrollment or attendance."

Computers and Internet Access: The new law will also make education IRAs a tax-sheltered way to save for a computer system for a child..Computers, peripheral equipment, software and Internet access are made eligible education IRA expenses for elementary and secondary school children. One exception: the law stipulates that education IRA funds can't be used for "computer software designed for sports, games or hobbies unless the software is predominantly educational in nature."

"It is unprecedented new ground gained for elementary and secondary school children in making home computers more affordable," said Senator George Allen (R-Virginia), who sponsored the computer provision. "I am thrilled that my number one campaign promise, to reduce taxes so that parents could more easily purchase computers, Internet access, and educational software for their K-12 children, is also my first legislative accomplishment."

The Financial Aid Trap

Lower- and middle-income parents who expect their child will be eligible for financial aid in college should think twice about taking advantage of education IRAs for college savings.

Education IRAs
The 2001 Act increases the allowed contribution amount to $2,000 in 2002 and does not increase it in later years. The increased contribution limit makes education savings accounts more attractive. As the charts below illustrate, if maximum contributions are made to an education IRA under the new law, a substantially higher account balance can result. The examples below assume that contributions are made at the beginning of the period and an 8% return is received.

Previous Law

Year

Age

Contribution

Value at end of year

2001

0

$500

$540

2002

1

$500

$1,123

2003

2

$500

$1,753

2004

3

$500

$2,433

2005

4

$500

$3,168

2006

5

$500

$3,961

2007

6

$500

$4,818

2008

7

$500

$5,744

2009

8

$500

$6,743

2010

9

$500

$7,823

2011

10

$500

$8,989

2012

11

$500

$10,248

2013

12

$500

$11,607

2014

13

$500

$13,076

2015

14

$500

$14,662

2016

15

$500

$16,375

2017

16

$500

$18,225

2018

17

$500

$20,223

2019

18

$500

$22,381

2001 Tax Cut Act

Year

Age

Contribution

Value at end of year

2001

0

$500

$540

2002

1

$2,000

$2,743

2003

2

$2,000

$5,123

2004

3

$2,000

$7,692

2005

4

$2,000

$10,468

2006

5

$2,000

$13,465

2007

6

$2,000

$16,703

2008

7

$2,000

$20,199

2009

8

$2,000

$23,975

2010

9

$2,000

$28,053

2011

10

$2,000

$32,457

2012

11

$2,000

$37,213

2013

12

$2,000

$42,351

2014

13

$2,000

$47,898

2015

14

$2,000

$53,890

2016

15

$2,000

$60,362

2017

16

$2,000

$67,350

2018

17

$2,000

$74,898

2019

18

$2,000

$83,051

The 2001 Act also amends current tax law as follows:

Expands the definition of qualified expenses to include public, private, and religious elementary and secondary education.
Increases the phaseout range for married couples to $190,000–$220,000
Allows contributions beyond age 18 for special needs beneficiaries. In addition, distribution would not be required when a special needs beneficiary reaches age 30.
Allows contributions by corporations and other entities regardless of the income of the corporation or other entity.
Contributions made by April 15 can be deemed to have been made for the prior year.
Allows the Hope or Lifetime Learning Credit in the same year that a distribution from an education savings account is excluded from income. The credit may not be taken on the amount excluded from income.
Allows contributions to QSTPs and education savings accounts in the same year.