Three Broad Savings Options in Bush Plan
Americans would be given the ability to save tax-free for any purpose -- and get new and more generous retirement savings options -- under the sweeping proposal that President Bush will announce Monday.
Treasury officials Friday unveiled a three-part approach to savings that would both consolidate workplace retirement savings options and boost savings choices outside of employer-provided plans.
“We all knew that something like this was coming down, but this is really big,” said Tim Kochis, a San Francisco-based financial planner. “This will be an enormous benefit, particularly for those who can afford to save in all these accounts.”
If Bush’s proposals become law, the current bewildering array of tax-favored savings plans -- including 401(k)s, individual retirement accounts and Roth IRAs -- would be replaced by three broad options.
A key element: Some types of savings plans that provide an immediate, upfront tax break, such as deductible IRAs, would be replaced by plans that provide tax savings when the money is withdrawn, generally years later. A new type of tax-favored savings plan also would be created.
Here are specifics of the proposal:
* Lifetime savings accounts, or LSAs, would be available to anyone, regardless of income or assets. LSAs could be used to save up to $7,500 per person per year for any purpose. The last feature is a departure from existing tax-favored savings plans, which require that the money be used for retirement, college or a small number of other goals.
Contributions to LSAs would not be tax-deductible, but both investment income accumulated within the account and withdrawals would be tax-free. Savers wouldn’t need to keep records on how the money was spent or how long it was held in the account.
Taxpayers would be given until Jan. 1, 2004, to convert balances from other special-purpose savings accounts -- such as Archer Medical Savings Accounts, Coverdell Education Savings Accounts and 529 plans -- into the more flexible lifetime savings accounts. This transfer would be taxable only if the contributions to the original account, such as a medical savings account, had been made pretax. Contributions to 529 plans and Coverdell accounts are made after tax. After-tax assets could be transferred into LSAs without triggering tax liability.
* Retirement savings accounts, or RSAs, would become the vehicle for most new contributions to retirement savings made outside of an employer-sponsored plan such as a 401(k). Individuals can now contribute to traditional deductible IRAs, Roth IRAs and/or nondeductible IRAs. Under the Bush proposal, RSAs would be the only option for this type of retirement savings.
RSAs would work much like a Roth IRA. Contributions would not be tax-deductible, but earnings accumulated in the account would grow tax-deferred. Withdrawals made after age 58 would be free of federal income tax. As with Roth IRAs, there would be no age at which individuals would be forced to withdraw their savings.
Contribution limits would rise to $7,500 annually with an RSA from the current $3,000 maximum IRA and Roth IRA contribution limits. So-called catch-up contributions, which allow those 50 and older to contribute a bit more to an IRA, wouldn’t be allowed with RSAs.
* Employer retirement savings accounts, or ERSAs, would replace current employer-provided retirement plans such as SARSEP and SIMPLE IRAs, as well as 401(k), 403(b) and 457 plans.
Employer retirement savings accounts would follow the existing 401(k) rules, which currently allow individuals to save up to $12,000 annually. Contributions are made before tax, which means they reduce the worker’s taxable income and thus current income taxes.
The contribution limits on ERSAs would increase -- just as 401(k) limits are slated to rise -- to $15,000 by 2006. These accounts also would allow those 50 or older to make catch-up contributions of up to $2,000 in 2003 and up to $5,000 in 2006.
A few retirement plans would remain unchanged, however. Keogh plans for self-employed individuals, so-called top-hat plans for executives of nonprofit organizations, defined-benefit pensions, profit-sharing plans, money-purchase pensions and stock bonus plans would not be affected.
Generally speaking, those plans allow greater annual contributions than the savings options offered through the Bush proposal.
“It almost sounds too good to be true,” said Edward O’Hara, a Silver Spring, Md.-based financial planner. “I would think this would be an incentive for people to save more.”
It also could cause investors to rethink how they’ve structured their investment portfolios, experts said. The reason: Anyone who was investing in tax-free municipal bonds might choose to put at least a portion of his savings in an LSA, which would have the same tax-free benefits but a potentially greater investment return.
The negative side for investors is that tax-deductible IRAs eventually would evaporate. That could make it more difficult for cash-strapped investors to save because they wouldn’t get the upfront tax benefit that allows them to quickly recoup a portion of the cost of saving, said Edward J. McCaffery, a professor of law at USC and author of a tax book called “Fair Not Flat.”
“The Roth model is good for students and people who are not earning a lot now. It is not the right treatment for the working classes,” McCaffery said. “I continue to think that the working classes are getting the short end of the stick.”
