Lifetime Savings Plan: More Flexibility, Temptation
A new type of tax-favored savings plan -- the lifetime savings account -- would become part of America’s financial-planning lexicon if President Bush has his way.
These accounts, proposed as part of a sweeping overhaul of savings alternatives included in the administration’s proposed budget, would give people at all income levels the option of saving in a tax-deferred account for any goal.
Though it is unclear whether Congress will approve the proposal, financial planners already are buzzing about the possibilities -- and the potential drawbacks.
The LSA would be the most flexible of the tax-favored savings plans available. But even seasoned planners disagree over which type of account would be the best choice for savers.
One reason for the uncertainty: Although the LSA’s proposed flexibility strikes some planners as highly attractive, others worry that savers might put money formerly ticketed for more restrictive retirement plans -- a 401(k), for instance -- into an LSA, and then not be able to resist the temptation to withdraw the money and blow it on a trip to Hawaii.
“Life is complicated, and it’s going to get more complicated,” said Peg Downey, a financial planner in Silver Spring, Md. “Eventually, people figure these things out, but when you just hand them a whole plate of choices, there’s usually some mayhem at first.”
What makes the decision tricky is that lifetime savings accounts would add to an already complex mix of tax-favored savings accounts aimed at financing goals ranging from medical expenses to college and retirement. Each of these accounts has its own set of advantages, disadvantages, restrictions and limitations.
Few Restrictions
LSAs could be used to fund any of these goals -- or simply to save additional cash for a vacation, a car or any other purpose.
LSAs would work much like a Roth IRA. Account holders could make annual contributions of as much as $7,500.
Unlike 401(k) plans or certain types of individual retirement accounts, the contributions wouldn’t be tax deductible -- they don’t reduce taxable income in the year they’re made. But money withdrawn from the account -- including any accumulated investment returns -- would be free from taxation.
Also unlike an IRA or 401(k), there are no restrictions on what LSAs can be used for or when the account can be tapped. Money in an LSA could be used at any time, for any purpose, without incurring taxes or penalties.
Assets now held in Coverdell education savings accounts, 529 state-sponsored college savings plans or medical savings accounts could be transferred to LSAs. Transferring money from a medical savings account would trigger current-year income tax on the amount transferred, but moving it into an LSA would eliminate the other restrictions on spending the money.
Generally, if money in a Coverdell or 529 account is used for anything other than education, a portion of the distribution is taxable at the account holder’s regular tax rate and also is subject to a 10% penalty. All the money accumulated in a medical savings account, if used for anything but qualified medical expenses, would be taxed and subject to penalties.
Even though LSAs are not being touted as a vehicle for retirement saving, a recent survey by Strong Capital Management Inc. found that the majority of respondents would use an LSA instead of a dedicated retirement account such as an IRA to save some money for retirement.
Strong’s survey also reveals that financial planners aren’t the only ones concerned that LSAs might make saving for retirement more challenging for some. About 45% of the respondents who said they would use an LSA to save for retirement also said they might be tempted to use the money for another purpose.
“For a highly disciplined saver, it’s not a problem to put money in the LSA,” said Rich Adkins, a certified financial planner with Arkansas Financial Group in Little Rock. “But there are some people who are only going to have money in a retirement fund because they couldn’t get to it without penalty. If you’re one of those individuals, you need the restrictions.”
Peter Syslack, manager of business development for Strong, agreed. If even part of someone’s savings would be used for retirement, he said, he probably would direct that person to an account that imposes penalties on early withdrawals.
Syslack said he might even steer savers to a 529 college savings plan -- for money that they know would be needed for college -- instead of an LSA.
Too Easy to Access?
“Because it’s easy to access, people might take money from their savings before they need to,” he said. “You have to try to put a line between goals to keep yourself disciplined and on track.”
Moreover, all the potential benefits of the LSA can’t compare with the benefits of contributing to a work-based retirement plan, such as a 401(k), said Mark Brown, a certified financial planner with Brown & Tedstrom in Denver.
The reason: The upfront tax benefits of 401(k)s allow individuals to save at a lower out-of-pocket cost. Also, many companies provide matching contributions on a set percentage of pay, a lucrative combination.
Consider a saver in the 30% marginal tax bracket whose company provides a 50-cent match for every dollar contributed to the 401(k). Because 401(k) contributions come out of pay before taxes are levied, each $100 saved costs this investor just $70 after tax. After the company match, this investor’s $70 out-of-pocket cost generates $150 in savings -- the equivalent of a 114% return.
Where there is no company match, some planners argue, upfront tax benefits are a better deal than the back-end benefits of an LSA only if the individual will fall into a lower tax bracket at retirement.
Brown said he favors deductions today over tax-free income in the future. He is somewhat less concerned about the “temptation factor” inherent in LSAs. For savers who have made the maximum contributions to their 401(k) accounts and other deductible plans, he said, the next best saving option is the one with the least restrictions.
If Bush’s proposal passes, that would be the LSA.
“If you can afford to fund them all, do it. They’re all good,” Brown said. “But if you have to choose, the fewer rules the better.”
*
(BEGIN TEXT OF INFOBOX)
Saving for life
President Bush’s proposed lifetime savings accounts would be popular with savers, according to a recent survey, but they also worry about frittering away their savings. Here are some of the survey’s results:
*
If they are enacted, would you take advantage of lifetime savings accounts (LSAs)?
Yes 71.3%
No 28.7
*
Would you save more because the LSA would enable investors to make withdrawals for any purpose, at any time, without taxes or penalties?
Yes 63.1%
No 30.9
Don’t know/didn’t answer 6.0
*
Would you use an LSA for some of your future retirement contributions instead of investing those contributions in a dedicated retirement savings account?
Yes 55.7%
No 34.0
Don’t know/didn’t answer 10.3
*
If you invested retirement funds in an LSA, are you worried that you might use the money for another purpose?
Yes 44.9%
No 52.3
Don’t know/didn’t answer 2.8
*
Source: Strong Capital Management
*
Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes .com. For past Personal Finance columns visit The Times’ Web site at www.latimes.com/perfin.
