You've undoubtedly heard about the three new accounts President Bush has proposed which are aimed at making saving easier and simpler, and thus, more appealing.
Before I discuss the details of these accounts, a word of advice: don't postpone plans to save for your retirement or a child's college education while you wait to see if any of these accounts actually see the light of day. At this point, according to the Treasury Department, the legislation needed to create these accounts has not even been introduced in Congress. I'm told there are "several interested sponsors" -- however, the reality is that it's going to take weeks to sort this out and to draft the actual legislation.
Which is to say, don't hold your breath. Congress is like a giant sausage-making machine: what goes in one end often comes out the other looking very different. We could see anything from none of these accounts being approved to all three or something in between. Furthermore, just because President Bush has set a July deadline to get this done doesn't mean Congress will follow his timetable. Remember, the Republicans have only a narrow majority in both the House and Senate -- and even some members of his own party have issues with Mr.. Bush's proposal. So this is far from a shoo-in.
The deadline to contribute to an existing IRA -- traditional or Roth -- is April 15. Period. Even if you file for an extension of your tax return, you do not get an extension on your IRA contribution. You'll be given an opportunity to convert your traditional IRA to the new "Retirement Savings Account"-- there's no deadline for doing this-- so even if the "RSA" becomes law, you're not out of luck. So go ahead and make at least your 2002 IRA contribution.
Here are the "bold new accounts" (Administration-speak) President Bush has proposed:
-- Lifetime Savings Account or "LSA": Every American, regardless of income, could put $7,500 a year into this account. You could take money out any time you want, for any reason (none needs to be supplied) and it would be entirely tax-free.
A couple could set aside $15,000. You could even stash money in someone else's account (a grandchild's, for instance) if you wanted to. (Note, though, that the $7,500 that goes to opening up an LSA for someone else would be considered a gift and go towards any gift amount for the year.)
And you don't have to be working to make a contribution. This means retirees could have LSAs. Your children could have LSAs. LSA s would be funded with after-tax money. In other words, you don't get to deduct your contribution. So why bother to make one? Well, just imagine never having to pay income tax on your mutual funds again.
-- Retirement Savings Account or "RSA" (do you detect a trend here?): Essentially this is a "Super-Roth." Contributions would be after-tax and can be as high as 100% of your income or $7,500 a year, whichever is less. Like current IRA rules, if one spouse works outside the home and the other does not, the stay-at-home spouse could have an RSA. Investments in an RSA would also grow tax-free.
In addition to allowing more than twice the contribution of an IRA currently, there would be no income restrictions on who is eligible to contribute to an RSA. There are also no required withdrawals once you reach a certain age.
If the President's proposal is enacted, the RSA would replace all IRAs. You wouldn't have to do a thing if you have a Roth IRA; it would just be re-labeled. You would be allowed to convert your traditional, tax-deductible IRA to an RSA by paying any income tax due. Again, there's no deadline on when you have to make the conversion. However, if you did it by the end of this year, you'd have four years to pay the tax bill.
If you decide not to convert, that's OK. But all traditional IRAs would be "frozen"; you could not make any additional contributions after this year. The RSA would be the only non-employer retirement account available. The main difference between an RSA and an LSA is that there would be a penalty if you withdrew any money from your RSA before age 58. (Death or disability would let you -- or your beneficiary -- escape the penalty.)
There is no restriction at all on withdrawals from an LSA. (Which is what worries me. See below.)
-- Employer Retirement Savings Account or "ERSA": All company-sponsored retirement plans that allow employees to make contributions would be folded into this single, simpler plan. In other words, all 401(k), 403(b), thrift, governmental 457, SIMPLE plans, and SARSEPs would morph into ERSAs. (457 plans sponsored by non-governmental employers would not change.)
Essentially, an ERSA would follow most of the same rules of a 401(K), with some notable exceptions that would greatly simplify the administration of the plan and, thus, reduce the red tape and the cost -- the two biggest reasons small businesses, in particular, say they don't offer a retirement plan to their employees.
In fact, while small businesses employ 40% of the nation's workforce, less than one in four provides any type of retirement benefit. According to the Treasury Department, this is one of the main reasons that only about 50% of all workers are covered by a retirement plan at work.
The amount an employee could defer into an ERSA would be $12,000 this year, increasing to $15,000 by 2006, with extra "catch-up" amounts for folks over age 50. These are the same amounts currently allowed under a 401(k), 403(b) or 457 plan. But they are much higher than the limits on SARSEP or SIMPLE plans.
So that's it: Savings and retirement accounts with simpler rules and uniformity, making them easier to understand and to use. I'm all for reducing and clarifying the ridiculously complex regulations that govern retirement accounts -- both those which are company-sponsored as well as IRAs.
All you have to do is look at the drop-off in IRA contributions in 1986 after Congress decided to only allow taxpayers with incomes below a certain level to deduct their contributions, and it's clear that complexity is a barrier to saving. In fact, the Treasury Department maintains untold numbers of Americans who would qualify for a tax-deductible IRA don't contribute because they're confused by the rules. If simplification can promote increased saving, that's a good thing.
But would it? Matthew Gnabasik, author of Smart Choices: Selecting and Administering a Safe 401(k) Plan, is afraid the changes to company retirement plans would have "unintended consequences."
While he believes mid-size and large employers would continue to offer plans to their workforce, he's concerned that the current proposals would provide less, not more, of an incentive for small businesses to sponsor retirement plans. He believes business owners are likely to conclude, "Why do I need to offer a retirement plan to my employees? Between me and my spouse we can save $30,000 a year through the RSA and LSA. And I can avoid the hassle and expense of any retirement plan through my company."
A founder of the Blue Prairie Group, a benefits consulting firm, Gnabasik predicts that without the convenience of automatic payroll deductions, the amounts that moderate and low-income workers save "would be seriously reduced."
Jeff Robertson, an attorney at Bullivant Houser Bailey, says he, too, "really worries" that lower-paid employees will save less. That's because ERSAs would do away with some of the current regulations designed to keep a plan from primarily benefiting higher-paid employees-- typically the owners and executives -- with little participation by those at the lower end of the pay scale.
Fact is, one of the main reasons owners of small businesses adopt retirement plans is self-motivated: they want a way to save for their own retirement. But in order to maximize their own contributions, they have to demonstrate to the government that lower-paid employees are also benefiting from the plan. If employees are not taking advantage of it, a company will sometimes offer a "matching" contribution as an incentive, agreeing to kick in a certain percentage based on what the employee puts into his or her account.
If the ERSA proposal is adopted, one of the more onerous non-discrimination provisions (the so-called "top-heavy rule") would be eliminated. And this would enable some companies to stop making matching contributions. Without this incentive, Robertson fears some employees will decide to stop putting their own money into the plan, leaving them in worse shape when they retire.
What about RSAs? Are Retirement Savings Accounts funded with after-tax money better than tax-deductible IRAs? That depends upon your tax bracket. If it's higher today than you expect it to be when you retire, then you're better off getting the tax deduction now. If you think you'll be in a higher tax bracket in the future, then you'd come out ahead by getting the tax break then (i.e. no tax on your gains). If you think your tax bracket will be the same, then there's no mathematical difference.
That is, provided you qualify for a tax-deductible contribution. Many Americans don't. In fact, if you're married and your adjusted gross income is over $160,000, then you and your spouse don't even qualify for an after-tax Roth IRA contribution. At any rate, if RSAs are approved, you won't have a choice: the tax-deductible IRA will be history. Frankly, I like the simplicity and equality of a single, individual retirement account with no income restrictions and the potential for all withdrawals to be tax-free.
On the other hand, I think the Lifetime Savings Account has a major weakness. Actually, we're the ones with the weakness. Americans are not exactly known as exemplary pillars of saving. The fact that you can pull money out of an LSA at any time and for any reason is too tempting for some -- perhaps most -- of us.
Can't you just hear it now: "Oh, I know that money's earmarked for Suzie's college tuition, but we really need that addition on the house/new car/vacation/face lift/flat screen TV/family room furniture, etc. " The LSA is like a giant cookie jar with the lid always open and beckoning.
And we are a culture that has perfected the art of "instant gratification." I hear too many sad tales from folks who don't know how they're going to pay for their kid's education, or are up to their eyeballs in debt to believe that an account you can withdraw from any time you want is going to help us "save." In fact, Matt Hutchison, an independent fiduciary and certified pension consultant, believes the LSA "will be harmful in the long run."
Hutchison thinks people will be inclined to contribute to an LSA before they put money into a retirement account precisely because there are no consequences of taking it out. "Because they can withdraw it, they will", he predicts. "It's going to create a savings leak." As a result, these folks will never accumulate the money they might have if they had used an account that imposed a penalty.
Which brings us back to where we started: at this point, these accounts are just a theory. Might happen. Might not. Will they probably look different if they are enacted? Yep.
So don't drive yourself (or me!) nuts "what-iffing" this to death. Continue making your 401(k) contributions, fund your IRA, keep putting money into your kid's 529 plan. I'll keep you posted on what -- if anything -- develops. And we'll all have plenty of time to make adjustments.
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