Hearings Begin on Rewriting the Rules for IRAs

Individual retirement accounts are again topping the legislative agenda, as the House Ways and Means Committee begins hearings to determine whether these tax-favored savings plans should be expanded.

There are three broad proposals on the table that would make IRAs more attractive, more widely available and more flexible. Although many similar proposals have been brought up--and shot down--in past years, many experts believe this year could be different.

Why? Because everyone from President Clinton to key lawmakers--both Republican and Democrat--have thrown their support to the ever-popular idea of expanding IRAs. While proposals brought by these various groups differ in some respects, they all have many important elements in common. There is no organized opposition to the moves. And, importantly, all the plans are relatively inexpensive--at least as far as billion-dollar tax breaks go.

“From my point of view, this is the year for the IRA,” says Robert C. Pozen, general counsel of Fidelity Investments in Boston. “You have several factors converging to make it possible--political consensus, low revenue numbers and all the benefits of increasing savings. I am very optimistic--and I’m not a wildly optimistic person.”

*

Few other tax breaks currently under consideration have as broad an appeal--or as significant an impact--for working Americans. Of the 10 points in the Republican’s “contract with America”--which includes capital gains cuts, a rollback in Social Security taxes and elimination of the tax penalty for working married couples--the provision promising to expand the IRA was among the most popular, according to a post-election survey conducted by Luntz Research Cos.

The IRA’s appeal is purely practical.

In its simplest form, making IRAs more widely available could provide a tax break worth between $560 and $620 to a huge swath of middle-income Americans. It also could spur people to save at a time when the U.S. savings rate is historically low--and when many are warning that today’s workers will face poverty in their golden years. A broad array of financial service companies, ranging from banks and brokerages to mutual fund companies, also favor the idea because it boosts savings--and managing those savings increases their profits.

*

Currently, taxpayers who earn less than $25,000 individually or $40,000 as a couple can deduct IRA contributions of up $2,000 on their income taxes. However, the deductions phase out at higher income levels for those who are covered by other qualified retirement plans--such as company pensions and 401(k)s. IRA deductions evaporate completely for those earning more than $35,000 individually or $50,000 as a couple. (Those who are not covered by any other qualified retirement plan can deduct IRA contributions, no matter their income.)

The money is subject to income taxes upon withdrawal, presumably at retirement, but in the meantime the money earns (and compounds) free of income taxes. Most people will earn less after retirement and thus are likely to pay a lesser tax rate then. Those who withdraw IRA money early are usually subject to a 10% penalty.

President Clinton’s proposal, part of his “middle-class bill of rights,” would do three things.

It would expand the number of people who could get tax deductions for IRA contributions by boosting the income levels subject to deduction phaseouts. Under his plan, individuals earning less than $70,000 and couples earning less than $100,000 could deduct at least a portion of their IRA contributions.

Clinton would also create a new type of non-deductible IRA, which would offer the benefit of tax-free withdrawals after five years. Another new IRA option would allow penalty-free withdrawals if the money is used for certain allowable activities--education, major medical expenses, first-time home purchase, long-term care for a parent or long-term unemployment.

A similar proposal was launched by Sens. John Breaux (D-La.) and William V. Roth (R-Del.). It would gradually restore universal availability of tax-deductible IRAs. (Until 1986, anyone could deduct IRA contributions. The 1986 Tax Reform Act set the deduction limits.) And it would create a second type of non-deductible IRA that could be tapped for retirement, college and medical expenses or to buy a first home.

The Republicans’ proposal in the “contract with America” is virtually identical to the second part of the Roth-Breaux proposal, aiming to launch a flexible but non-deductible long-term savings vehicle.

*

In addition, the Republicans would allow anyone with an old IRA to transfer the funds into one of the new “super IRAs.” Money transferred into the new accounts would be subject to income taxes but no penalty. The taxes could be paid over a four-year period.

For individuals, any of these proposals would solve one of the most troubling shortcomings of today’s IRA programs: access. Because it is now so costly to pull money out of an IRA before retirement, many people simply don’t contribute. They lose out on years of tax-free compound earnings as a result.

“This (Republican plan) encourages people to contribute who would normally say, ‘I can’t because I need to buy a house,’ or ‘I need the money for an emergency,’ ” says Barbara E. Casey, president of Dreyfus Retirement Services in New York. “At the bottom end of the income spectrum, you’d see more saving.”

Still, while expanding the IRA appears to be on the fast track, there’s always a chance that the proposals will again be derailed.

Kathy M. Kristof welcomes comments and suggestions for columns but regrets that she cannot respond individually to letters and phone calls.