The President's Savings Proposals: Tax-Free Savings and Retirement Security

The President’s Savings Proposals:
Tax-Free Savings and Retirement Security
Opportunities for all Americans

This week the Treasury Department announced that the President’s FY 2005 Budget includes the following savings initiatives: Retirement Savings Accounts, Lifetime Savings Accounts, Employer Retirement Savings Accounts, and Individual Development Accounts.

The first proposal would create two consolidated savings accounts: Retirement Savings Accounts (RSAs) and Lifetime Savings Accounts (LSAs) that will allow everyone to contribute -- with no limitations based on age or income status. Individuals will be able to convert existing tax-preferred savings into these new accounts in order to consolidate and simplify their savings arrangements. You may also view the President's Budget Message

  • RSA and LSA contribution limits will be $5,000 per year. This contribution limit is modified from last year’s FY04 Budget proposal, which had a contribution limit of $7,500.

The second proposal would create Employer Retirement Savings Accounts (ERSAs) to promote and simplify employer sponsored retirement plans. The proposal would consolidate 401(k), SIMPLE 401(k), 403(b), and 457 employer-based defined contribution accounts into a single type of plan more easily established by any employer.

  • This proposal is modified from the previous FY04 Budget proposal to enhance flexibility and encourage small businesses to fund a custodial ERSA for their employees. Employers with 10 or fewer employees would be able to fund an ERSA by contributing to a custodial account, which is similar to a current-law IRA.

The third proposal would create Individual Development Accounts (IDAs) help lower-income individuals save. This proposal would provide dollar-for-dollar matching contributions of up to $500 targeted to lower income individuals. Matching contributions would be supported by a 100 percent credit to sponsoring financial institutions.

The President’s Proposal to Expand Tax-Free Savings Description of Proposal

RETIREMENT SAVINGS ACCOUNTS (RSA)

  • $5,000 annual contribution limit (indexed for inflation).
  • Available to all individuals – no income limits (contributions cannot exceed compensation), no age limits.
  • Contributions would be nondeductible (like Roth IRAs).
  • Earnings would accumulate tax-free, and qualified distributions would be excluded from gross income.
  • Qualified distributions could be made after age 58 or in the event of death or disability.
  • Nonqualified distributions: Distributions in excess of prior contributions would be included in income and subject to an additional tax.

Conversions to RSAs: Roth IRAs, Traditional and Nondeductible IRAs

  • Roth IRAs would be renamed RSAs and benefit from the new rules for RSAs.
  • Existing traditional and nondeductible IRAs could be converted into an RSA by taking the conversion amount into gross income, similar to a current-law Roth conversion.
  • No income limit would apply to the ability to convert.
  • Existing traditional and nondeductible IRAs that are not converted to RSAs could not accept any new contributions after 2004.
  • New traditional IRAs could be created to accommodate rollovers from employer plans, but they could not accept any new individual contributions.
  • Individuals wishing to roll an amount directly from an employer plan to an RSA could do so by taking the rollover amount (excluding basis) into gross income (i.e., "converting" the rollover, similar to a current law Roth conversion).
  • Several of the withdrawal exceptions would be eliminated, increasing the likelihood that money set aside for retirement is there for retirement.

LIFETIME SAVINGS ACCOUNTS (LSA)

  • $5,000 annual contribution limit (indexed for inflation).
  • Available to all individuals – no income limits, no age limits.
  • Contributions would be nondeductible (like Roth IRAs).
  • Earnings would accumulate tax-free and all distributions would be excluded from gross income.
  • No minimum required distribution rules would apply at any age throughout owner’s life.
  • Contribution limit of $5,000 applies to the individual owner of the account, not the contributor.
  • Contributors could make annual contributions to the accounts of other individuals.
  • Annual aggregate contributions to an individual’s accounts could not exceed $5,000.

Consolidation to LSAs:

  • Individuals could convert balances from Coverdell Education Savings Accounts (ESAs) or Qualified Tuition Plans (QTPs) to LSAs.
  • Individuals could continue to contribute to ESAs and QTPs as under current law.
  • Health Savings Accounts (HSAs) and Archer Medical Savings Accounts (MSAs) would be retained.

EMPLOYER RETIREMENT SAVINGS ACCOUNTS (ERSA)

One Retirement Plan: Employer Retirement Savings Accounts would combine the array of existing retirement plans into one simple uniform regime:

  • 401(k)
  • SIMPLE 401 (k)
  • 403 (b)
  • Governmental 457
  • SARSEPs
  • SIMPLE IRAs

Access: Available to all employers

Simplified Administrative Rules: The new plan would be much simpler for employers to administer, so employers who are not already sponsoring a plan, especially smaller employers without the resources for administering plans, will be more likely to offer a retirement savings program for their employees.

  • A single nondiscrimination test would apply to ERSA contributions, as compared to the double test that currently applies to 401(k) plan contributions.
  • Employers could avoid nondiscrimination testing altogether if they satisfy a simplified safe harbor.
  • ERSAs sponsored by state and local governments and section 501(c)(3) organizations would not be subject to nondiscrimination testing under certain circumstances.
  • A simple custodial ERSA would be allowed for employers with 10 or fewer employees to help reduce costs to small businesses and encourage them to offer plans. The custodial ERSA would be similar to a current-law IRA. Employers would be exempt from annual reporting requirements and provided relief from most ERISA fiduciary rules similar to the relief provided to sponsors of SIMPLE IRAs.

The rules applicable to defined benefit plans would not be affected by this proposal.

INDIVIDUAL DEVELOPMENT ACCOUNTS (IDAs)

Individual Development Accounts would create accounts with dollar-for-dollar matching contributions targeted to lower income individuals.

  • Dollar-for-dollar matching contributions provided to individuals up to $500.
  • Single filers with incomes below $20,000, joint filers with incomes below $40,000 and head of household filers with incomes below $30,000 would be eligible.
  • Matching contributions supported by 100 percent tax credit for sponsoring financial institutions that provide matches to individuals.
  • A $50 per account credit for financial institutions to cover ongoing costs of maintaining and administering each account and providing financial education to participants.
  • Qualified withdrawals of contributions and matching funds for higher education, first-time home purchase, and small business capitalization.

The President’s Proposal to Expand Tax-Free Savings Important for the Future

Continues to Build an Ownership Society

  • The United States is increasingly an ownership society. More than half of all households – 84 million individual investors – own stock directly or through stock mutual funds.
  • The savings package further promotes an ownership society by:
    • improving access by removing barriers to tax preferred saving.
    • making savings simpler by reducing complexity and unifying the rules.
    • improving fairness by providing the benefits of tax preferred savings to those least able to save for the very long-term.
  • Through the savings package, taxpayers get the benefit of paying the tax man upfront, rather than when withdrawing funds for retirement or other needs. Taxpayers' receive the full return on investments giving them greater certainty about the amounts available for their retirement and other needs.
  • A majority of taxpayers will be able to move all of their savings in a few short years into tax free savings accounts. This will allow taxpayers to avoid the complexities of reporting financial income on their tax returns and filing a schedule B and Schedule D.
  • Increased education and financial literacy will help raise awareness of the importance of savings.
    • Financial services firms will be more focused on counseling clients on maximizing financial security rather than the intricacies of the tax rules – adding value instead of paper work.

Enhances Low- and Moderate-Income Savings Opportunities

  • The savings package simplifies individuals’ savings decisions.
    • Complex and confusing eligibility rules are replaced with one rule for both LSAs and RSAs: everyone can contribute.
    • The special rules that dictate what qualifies as a penalty free withdrawal are replaced with one rule under LSAs: all distributions are tax-free.
  • Tax preferred savings would become universally available.
    • Individuals’ saving will correspond more directly to their needs rather than to the special uses prescribed by the tax laws.
    • The availability of tax preferred savings opportunities to the low income under current law is largely illusory. The flexibility of LSAs allows access to tax preferred savings regardless of an individual’s savings horizon and use.
    • The current alphabet soup of accounts are available to low and moderate income taxpayers, but their shear complexity, for all practical purposes, closes them to low and moderate income taxpayers who don’t have access to the sophisticated tax and financial advice needed to take advantage of them.
    • Low-income individuals, in particular, may not have the resources to save for long into the future.
    • Low-income individuals are the most likely to need their savings in an emergency, and the most likely to pay penalties for early withdrawal under current law.
  • Uniform and simple rules will encourage financial services firms to market tax preferred savings more aggressively and to spend their resources on financial education and literacy.
  • Dollar-for-dollar matching contributions up to $500 would be made available to lower income individuals through Individual Development Accounts (IDAs). The matching contributions would be supported by a tax credit to financial institutions.

Promotes Retirement Savings

  • The ERSA proposal simplifies and unifies employer plan rules in a number of important ways. ERSAs will be much easier for employers to adopt and administer and will help reduce the costs to employers.
  • ERSAs consolidate all types of employer plans into a single simplified plan.
  • ERSA custodial accounts, available to employers with 10 or fewer employees, would be exempt from annual reporting requirements and provided relief from fiduciary rules.
  • Lower administrative costs under ERSAs will translate into higher investment returns to employer plan participants, which will help encourage participation.

More uniform employer plan rules may lead to greater competition between financial services firms, which may further help drive down costs and increase returns to investors.

Encourages Savings and Promotes Economic Growth

  • The package promotes savings in several ways.
    • These proposals remove the current law penalty on saving. The after-tax return to savings is increased through greater access to tax preferred savings. Higher after-tax returns encourage savings.The simpler and more uniform rules for individual savings vehicles will encourage more savings.
    • Lower costs for setting up and maintaining employer plans will increase returns and encourage additional savings.
    • More uniform rules for employer plans will foster more competition for investor funds among financial services firms. More competition lowers costs and translates into higher returns to investors, further encouraging savings.
  • Greater savings translates into more investment, greater capital accumulation, and higher living standards in the future.
  • Greater savings means a more secure future for Americans of all income levels.

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