Saving for Retirement? California's Conformity Scramble May Not Arrive in Time

California legislators are scrambling to enact tax conformity legislation, but there are no guarantees that relief will arrive in time.

Currently, California tax law does not conform to provisions of the federal Economic Growth and Tax Relief Reconciliation Act of 2001 that apply to retirement plans and certain trusts, including provisions relating to annuities and proceeds of life insurance contracts, IRAs, employee annuities, qualified state tuition programs, retirement savings, deferred compensation plans, employee funded pension trusts, VEBAs and group legal service plans.

Those differences may create problems for individual Californians who are unaware of the discrepancy, as well as for pension plans that accept contributions which exceed California¹s maximum.

Several bills have been introduced to deal with the lack of conformity and Gov. Gray Davis has included revenue projections in his budget that consider the estimated $44 million annual cost of conformity. In the interim, taxpayers should be aware that the issue exists, and CPAs should carefully advise their California clients since lack of conformity could create significant tax problems for the unwary.

Education IRAs
Education IRAs have several key nonconformity areas. Current California law limits education IRA contributions to $500 annually, while federal law, beginning in 2002, allows $2,000 and permits corporations to contribute. Federal law would allow expenditures for qualified elementary and secondary education to be made from the education IRA while state law applies only to college.

Additionally, California allows one qualified tuition plan, ScholarShare, and taxes the income from the plan at the beneficiary level. However, federal law would exclude from gross income the education-related distributions from a qualified tuition plan and permit expenses for special needs services of a special needs beneficiary.

IRA Contributions
California law limits annual IRA and Roth IRA contributions to $2000, but federal law would allow annual contributions of up to $3,000 for 2002­04; $4,000 for 2005­07; and beginning in 2008, $5,000, with indexing increments of $500 thereafter.

Federal law also provides for catch-up contributions for both traditional and Roth IRAs. Under this law, individuals age 50 and older are allowed to contribute an extra $500 to qualified retirement savings for 2002­05. That amount is scheduled to increase to $1,000 per year in 2006.

Defined Contribution Plans
California law limits contributions to defined contribution plans to $35,000, while the federal law limit is $40,000 with indexing in $1,000 increments. The defined benefit payable is limited to $140,000 annually, while federal law is capped at $160,000.

Federal law would allow elective deferrals to 457 plans of $11,000 in 2002; $12,000 in 2003; $13,000 in 2004; $14,000 in 2005; and $15,000 in 2006, with indexing thereafter. However, California remains at a maximum of $8,500 for 457 plans.

Limits for 401(k) and 403(b) plans under federal law were increased to $11,000, with annual incremental increases of $1,000 until 2006 when indexing increments kick in, while the California limit remains at $10,500.

California law requires that the maximum contributions to 401(k) and 457 plans be coordinated, but federal law would allow taxpayers to make the maximum contributions to both plans simultaneously.

So a taxpayer under age 50 who is saving for retirement in a conforming state would be allowed to contribute $11,000 to a 401(k) and $11,000 to a 457 plan. But Californians could only contribute a maximum of $10,500 to a 401(k) plan.

Federal law also allows rollovers of government 457 plans, 403(b) and IRAs to other eligible retirement plans, but California law restricts rollovers and could tax those events at the state level.

Pending Legislation
Although changes to the federal tax law have been public since last summer, the public remained relatively unaware of this issue until pension fund administrators began implementing the plan changes to allow employees to take advantage of the new federal law. Early this year, the media began to cover the nonconformity issue and momentum has built for California conformity.

Assembly Member John Campbell and Senator Jack Scott have introduced legislation to accomplish an immediate and retroactive conformity of the retirement and savings issues.

SB 657 (Scott) is awaiting a hearing in the Assembly Revenue and Taxation Committee, as is AB 1743 (Campbell).

Assembly Member Ellen Corbett also introduced AB 1744, but her bill has been amended to correct only a conformity problem related to rollover provisions and the purchase of service credits by public employees.

Support Conformity
CPAs and their clients are encouraged to write to their legislators expressing support for pension and retirement savings conformity.

Other states that are attempting to enact last minute conformity provisions include Arizona, Georgia, Hawaii, Idaho, Indiana, Iowa, Kentucky, Maine, Massachusetts, Minnesota, Mississippi, Nebraska, New Jersey, North Carolina, South Carolina, West Virginia and Wisconsin. For conformity updates, go to: http://calcpa.iris1.com.

Bruce C. Allen is CalCPA's director of government relations.

© 2002 California Society of Certified Public Accountants. For reprint permission, contact Aldo Maragoni, managing editor.