Bush Plan Would Offer 4 Tax-Free Ways to Save
The budget proposed by President Bush this week includes four new types of savings accounts that could streamline retirement saving for Americans and offer new, tax-free ways to sock away money for a wide range of goals.
Similar proposals were shelved last year amid concerns that they would curtail tax revenues at a time of huge federal deficits. But administration officials say they are hopeful the second attempt will succeed.
“The administration intends to work closely with Congress to see them enacted,” said Tara Bradshaw, spokeswoman for the U.S. Treasury Department.
Here is a look at what’s on the table:
Question: What’s been proposed and why?
Answer: Bush wants to create a new, all-purpose tax-free account that could be used for everything from college savings to emergency expenses. He also wants to replace a variety of retirement-oriented tax-free savings plans, from 401(k)s to individual retirement accounts, with two new types of accounts that would merge and simplify the existing thicket of retirement-account rules. Bush also wants to create a standardized version of an existing savings plan aimed at low-income workers.
Q: Why are some in Congress opposed?
A: Critics say the changes would disproportionately benefit the wealthy, who have the most money to save and who would get the biggest benefit from moving assets into tax-free accounts. Proponents counter that the accounts would encourage savings at a time when the national savings rate is lamentably low.
Q: What are the new plans called, and what would they replace?
A: Here’s the lineup:
* Retirement savings accounts would replace all types of individual retirement accounts.
* Employer retirement savings accounts, a reworked version of the 401(k), would replace employer-sponsored plans such as 401(k), 403(b) and 457 plans.
* Lifetime savings accounts would allow anyone, regardless of income, to save and withdraw money tax-free for any purpose. These are new.
* Individual development accounts, a little-known matched savings plan for low-income workers, would become nationally available and standardized.
Q: Why does Bush want to eliminate the 401(k)?
A: The 401(k) would be replaced by employer retirement savings accounts, or ERSAs, but it’s more of a renaming than an actual replacement. It’s actually the other half-dozen, lesser-known retirement savings plans, such as 403(b)s and 457 plans, that would be eliminated and merged into the new plan.
ERSAs would work just like 401(k)s, but the maximum annual contribution would rise to $15,000, and some of the rules for employers would be simplified.
Q: How would an ERSA work?
A: Experts say most employers would probably stick with the standard 401(k) formula, which takes contributions out of pay before taxes are computed, reducing taxable income. But Bush wants to give employers the option of setting up nondeductible ERSAs. These would work like Roth IRAs -- contributions wouldn’t be deductible, but the money, including any investment income, would be tax-free at withdrawal.
Q: What would happen with my existing 401(k)? Would it still be called that?
A: The plan would probably remain the same, but the name might change.
Q: What would happen with IRAs?
A: Deductible individual retirement accounts, which now allow low- and middle-income workers to deduct as much as $3,000 in IRA contributions, would be eliminated. They would be replaced with the new retirement savings accounts, which are similar to Roth IRAs. Contributions would not be deductible, but money withdrawn at retirement would be tax-free.
Q: What happens to my existing IRA?
A: If the plan passes, people with established IRAs could transfer the money into a retirement savings account, or RSA, paying tax on any untaxed assets at the time of transfer, or they could leave them alone. Taxpayers would not be able to make additional contributions to any type of IRA. But they could open an RSA in addition to owning old IRAs, if they choose.
Q: What’s a lifetime savings account?
A: It also would work much like a Roth IRA -- contributions aren’t deductible and withdrawals aren’t taxed. The big difference: There would be no restrictions on withdrawals. Money in a lifetime savings account, or LSA, could be used at any time for any purpose -- such as buying a house or a car or paying college tuition or medical expenses.
Q: Would the LSA replace college savings or medical savings plans?
A: No. These options would remain and taxpayers could choose the best plans for their needs.
Q: What’s an individual development account?
A: IDAs are a little-known matched savings account program for low-income workers. These accounts are offered currently through small community programs in hundreds of cities. However, the existing programs are hard to find and have varying qualification standards. The president’s proposal would standardize the criteria. Low-income individuals would be able to get as much as $500 in matching funds that could be used to buy a first home, pay for higher education or start a small business.
