Congress is pretty cool to most of the ideas, which were dropped on its head without any warning. But don’t dismiss the plans just because they’re going nowhere now. Bush has a larger purpose than merely streamlining the savings system.
Radical conservatives, who count the president among their number, want to eliminate taxes on wealth–including the tax on dividends, interest and capital gains held in taxable accounts. These new plans would do the job. The richer you got, the more tax-free income you’d have to spend.
Two problems: The tax-free proposals don’t apply to wealth accumulated in 401(k)s, the most common savings plan for moderate earners. And they may encourage small companies to drop (or fail to start) employee plans. The big winners are the usual suspects–people living comfortably near the top of Money Peak.
The president has laid two plans on the table for individuals and one for employers. Here are their outlines:
A Lifetime Savings Account (LSA). Anyone could contribute up to $7,500 a year (that amount increases with inflation). You could set up plans for other people, too. There’s no tax deduction when you put the money in but all the earnings grow tax-free. You can take money out at any time, for any purpose, with no penalty and no tax on your gains. Think of it as a tax-free checking and investment account.
A Retirement Savings Account (RSA). This plan replaces both traditional and Roth individual retirement accounts. You could contribute up to $7,500 a year plus another $7,500 for your spouse. You get no deduction upfront, but could start withdrawing your savings, tax-free, as early as 58. If you don’t need the money, you could leave it, tax-free, to your kids.
IRA expert Ed Slott figures that he’d set up LSAs for himself and his wife and gradually convert his IRAs to RSAs. He’d be sheltering $30,000 in savings and investments every year. “In the long run,” he says, “I’d move most of my taxable funds to tax-free accounts. Then I’d live on tax-free money when I retired.” Sounds like a plan, as long as you have $30,000 to spare.
An Employer Retirement Savings Account (ERSA). This would replace Simple plans for small businesses, SEPs for the self-employed, 401(k)s, thrift plans, 403(b)s for teachers and government 457 plans. You could contribute up to $12,000 a year (plus an extra $2,000 if you’re 50 and up), rising to $15,000 (plus $5,000) by 2006. Contributions are tax-deductible and earnings are taxed when withdrawn, just as they are now.
What’s not to like? Let’s start with those RSAs. You can’t deduct your contribution as you can with IRAs. So fewer middle-income people could afford an RSA, or afford to put in as much. Even now, IRA contributions are made by only around one in 10 of eligible savers.
The LSAs are dandy, but I doubt that they’ll create more savings, as the president claims. Instead, those who already save–like Slott–will enjoy their gains tax-free.
As for ERSAs, it makes good sense to provide the same kind of plan for every workplace. But will small businesses adopt them? Karen Field, head of compensation and benefits for the consultant KPMG, thinks they will. “A simpler plan would be easier to design and explain, which is half the battle,” she says.
Ed Ferrigno, vice president of the Profit Sharing/401K Council, disagrees. “If a small business owner can invest $30,000 without setting up a plan, it’s a no-brainer. You skip the plan,” he says. The boss can do fine, without the expense of contributing money for employees. If workers set up their own LSAs or RSAs, the company might add a tad–but it could arbitrarily give money to favored employees and not to others, says benefits expert Mark Iwry, a senior fellow at the Brookings Institution. Employers couldn’t do that now.
Big companies would offer ERSAs, which are 401(k)s by another name. But Bush’s proposal weakens an employer’s incentive to encourage the majority of workers to participate.
Switching to ERSAs might give teachers and others with 403(b)s a chance to get plans with better investments, says Dan Otter of 403bwise.com. Right now they’re generally stuck with high-cost insurance annuities. But that problem could be solved without helping the higher-paid avoid even more taxes than they do today.
There’s no reason to change your savings plan because of the president’s proposal. You should put more money aside, no matter how it’s taxed. The trend is to loosen the social bonds that led companies to support workers and the government to maintain safety nets. The wealthy will manage. It’s everyone else I worry about.
