They're baaack! Remember those new savings accounts President Bush proposed last year to replace existing savings vehicles, such as IRAs and a host of confusing employer-sponsored retirement plans? They cropped up again in the President's 2005 budget, along with an additional account. Here they are:
RSA: Retirement Savings Account
LSA: Lifetime Savings Account
ERSA: Employer Retirement Savings Account
IDA: Individual Development Account
All of these accounts are aimed at creating what the Administration calls "The Ownership Society" -- one based on building wealth through accumulating assets such as mutual funds and homes. It's about weaning people from expecting the government to take care of them and accepting more responsibility to provide for their own financial futures.
The "Retirement Savings Account" would replace all three different types of IRAs we have now. Essentially, an RSA would resemble a Roth IRA because contributions would be made on an after-tax basis. All withdrawals taken after age 58, or upon the death or disability of the RSA owner, would be income tax-free.
Another major change is that everyone could contribute $5,000 a year to their RSA, regardless of their income. In addition, if you didn't need the money, you would not have to start Required Minimum Distributions at age 70 1/2. As a result, the money could remain in the account and you would continue to benefit from its tax-deferred growth potential.
So what would happen to existing IRAs if RSAs were enacted? They'd be frozen. You could not continue to add new money to any existing IRAs after 2005. However, you would have the option of converting your IRA to a Retirement Savings Account by paying any income tax which might be due. There is talk of allowing you to spread out the tax payments over several years to make this more affordable.
In addition to an RSA, you could also contribute up to $5,000/year to an LSA, where it would also have the ability to grow tax-free. The attraction -- and danger-- of this account is that you could take your money out any time you want and for any purpose. According to Chad Kolton, spokesperson for the White House Office of Management and Budget, the problem with existing long-term savings vehicles such as IRAs is that they restrict your access to your money by imposing penalties if you withdraw it too early. "Low- and moderate-income savers are more likely to need to tap that money in an emergency," he says, "making them reluctant to put money into these accounts."
The idea behind the LSA, he says, to give people the "freedom and flexibility" to tap their savings for major life expenses such as the purchase of a home, a child's or their own education, or some other expensive purchase.
Think about it: a married couple could set aside $20,000 each year if each spouse maxed out these two accounts and the money would grow tax-free.
Which is exactly the criticism opponents level at these accounts: how many people can afford to take full advantage of them? That leads to the label that they're only going to benefit "The Rich."
But Congressman Paul Ryan, a Republican on the House Ways and Means Committee, says whether or not someone is able to max out their contributions to an LSA misses the point. "Wealthy people are already saving. We want to make it so all people save."
Pam Olson, the Treasury's Assistant Secretary for Tax Policy, insists that making Lifetime Savings Accounts accessible and easy to understand will encourage everyone to become better savers and investors. She points out that when IRAs were fist introduced in the early 1980s and anyone could contribute to one, "the average income of IRA contributors dropped from $41,000 to $29,000. People will save if we tell them it's important and give them opportunities to do it that are not overly complex."
Says Congressman Ryan, "LSAs are a tool for lower-income workers to set aside savings with the comfort of knowing that if they need the money they can get to it. This will help everyone become a member of the savings and investor class."
The White House is also hoping that simplifying the way these accounts operate will encourage more financial institutions -- banks, S&Ls, mutual funds -- to promote them and help boost the nation's abysmal personal savings rate of 2.3%. Says Olson, "I want to see as many ads for LSAs as we currently do for lipstick and light beer."
Which brings us to the ERSA, or Employer Retirement Savings Account. Let's face it, folks, the rules that currently govern company-sponsored retirement plans are a quagmire of complex, convoluted, and sometimes conflicting regulations. Most plans must file reports each year with the IRS ensuring they are in compliance. Many, such as 401(k)s, require annual testing to be sure they don't violate "anti-discrimination" and other guidelines. It's time-consuming and costly.
Small business owners, who collectively employ more Americans than any other sector of the economy, overwhelmingly choose to not offer retirement plans to their employees. Among the top reasons: the expense and bureaucratic red tape involved. ERSAs are aimed at reducing or eliminating much of that.
Essentially, an ERSA would operate much like a 401(k), but simpler. Any existing company retirement plan such as a SIMPLE, 403(b), 457, SEP or SARSEP would be frozen. The money currently in those accounts could either remain there or be rolled into an ERSA. The maximum that could be added to anyone's individual account in a year -- from both employer and employee contributions -- would be $41,000, the current limit on 401(k)s. (All of the dollar limits, including those for the other types of accounts, would be increased periodically to adjust for inflation.)
Last but not least, the Bush Administration is proposing the creation of the new "Individual Development Account" to specifically encourage lower-income Americans to save and invest. To qualify for an IDA, the maximum adjusted gross income for single filers would be $20,000; for heads-of- household and married couples who file jointly, it would be $30,000 and $40,000, respectively.
Contributions to an IDA would receive a dollar-for-dollar match of up to $500/year from the government-approved agency or financial institution sponsoring the IDA. That sponsor would, in turn, be reimbursed by the federal government. Sponsors would also have to provide financial education to IDA owners.
So someone who contributes $500 to an IDA would end up with $1,000 in his account. Unlike and RSA, LSA, or ERSA, the owner of the IDA would owe income tax on the earnings the IDA generates each year. However, matching funds would not be considered income; there would be no tax on them. The Treasury Department says a prototype IDA program has been in existence for several years; this would simply expand that to the national level.
Provided IDA money was used to pay for "qualified" expenses including the purchase of a first-time home, college tuition, or to start a small business it could be withdrawn it at any time. To avoid abuse, the mutual fund or bank acting as custodian of the IDA would send the money directly to, say, the university or the financial institution issuing your mortgage.
While the IDA owner would withdraw her own contributions at any time, she would forfeit all or part of the matching money if she did so. Once she reaches age 61, however, all of the money is hers and could be used for any purpose.
Let me wrap this up with a few concluding thoughts.
Personally, I'm all for simplifying the ridiculously complex rules surrounding retirement accounts. And anything that gets us to think like long-term investors instead of immediate gratification hounds is also a good thing. But keep this in mind: the Administration proposed essentially the same accounts a year ago and they went nowhere. That's because only Congress has the authority to introduce legislation. And there was no support in Congress for these sorts of changes. So don't throw away the employee guide to your company retirement plan just yet.
Next week I'll share with you why I don't think LSAs are going to make 529 College Savings Accounts disappear. Hint: annual limits and estate taxes.
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