Tax Law Changes Mean Money for Education
and Retirement

by Jackie Perlman

The Economic Growth and Tax Relief Reconciliation Act of 2001 introduced or changed hundreds of tax provisions. In addition to across-the-board tax cuts, the new law affects many aspects of tax and personal finance. Two important areas of concentration are in education and retirement. Here are some highlights of provisions that are effective with the 2002 tax year.

Education Incentives

The Tuition and Fees DeductionÑalso called the "higher education deduction," this is a new benefit available from 2002 through 2005. It is an "above-the-line" deduction (meaning you do not have to itemize to claim it) of up to $3,000 of qualified tuition expenses. This is a per-tax-return deduction available for the taxpayer, his or her spouse, or dependents. There is an Adjusted Gross Income limit of $130,000 for married taxpayers filing joint returns and $65,000 for all others. Taxpayers who are phased out of other education benefits, such as the Hope and Lifetime Learning credits, may qualify for this new deduction.

Coverdell Education Savings Account--Formerly known as the Education IRA, an ESA is a trust established to pay for qualified expenses of the beneficiary. ESA earnings are tax-deferred and distributions for qualified expenses are tax-exempt. AGI limits apply. This type of account has been around for several years, but starting in 2002 allowable contributions have quadrupled to $2,000 per beneficiaryÑmaking the ESA an attractive vehicle for college savings. Another important change: ESA distributions may now be used for elementary and secondary education expenses. Also, an ESA distribution may be rolled to a Qualified Tuition Program once in any twelve month period.

Qualified Tuition Programs (Section 529 Plans)--A QTP is another type of account set up to pay qualified education expenses of the beneficiary. QTPs may be either savings/investment type accounts or prepaid tuition credits. Growth is tax-deferred. The big news for 2002 is that QTP distributions from state-run plans are entirely tax free as long as the money is used to pay for qualified education expenses. In addition to state sponsorship, private institutions may now sponsor prepaid credit type plans.

Which plan is best? You may now contribute to both an ESA and QTP in the same year. There are many choices of QTPs and you may roll funds from one to another for the same beneficiary. Some states offer tax deductions for their own plans. It is always best to check with your financial professional to help select the best possible savings vehicle.

Retirement Incentives

Increased Contribution Limits--IRA contribution limits have increased to $3,000 for both traditional and Roth IRAs. Taxpayers who are age 50 by December 31, 2002, may make an additional "catch-up" contribution of up to $500. Employer plans have increased contribution and catch-up provisions as well. Example: With 401(k)s and 403(b)s, the limit is $11,000 plus there's a catch-up contribution of $1,000.

Saver's Credit--As an added incentive to save for retirement, the new law also introduced a saver's credit of up to $1,000. The credit can be taken in addition to claiming an IRA deduction or contributing pre-tax to an employer plan. The AGI limitations are low: $50,000 for married couples filing joint returns; $37,500 for heads of household; and $25,000 for others. If you have just graduated from college and joined the work force or if you start a high-paying job late in the year you may be eligible for this credit.

Myth: With today's uncertain market and low rates of return, it is not worthwhile to save. Fact: A young person who saves $2,000 a year from age 21 through age 35, at just a four percent rate of return, will have saved over $135,000 at age 65--on a $30,000 investment. That is the magic of compounding and the time value of money. The new law strongly emphasizes and encourages retirement plan savings.