Treasury Releases Details of Proposed Changes to Retirement Accounts

Provided by CCH

Following several days of speculation over new retirement plan proposals that had been circulated privately among top policymakers by Bush administration officials, the Treasury Department, on January 31, released details of President Bush's budget proposals to greatly expand retirement accounts. The first proposal would create two new savings accounts: Lifetime Savings Accounts (LSAs) and Retirement Savings Accounts (RSAs), which will allow all Americans to contribute, regardless of age or income. The second proposal would create Employer Retirement Savings Accounts (ERSAs), to promote and simplify employee benefit plans by consolidating Code Sec. 401(k), SIMPLE 401(k), Code Sec. 403(b) and Code Sec. 457 plans into a single plan type that employers could more easily establish and maintain.

The new rules appear to indicate a recognition by the Bush administration that more must be done to encourage people to save for their future. As President Bush noted, "saving is the path to independence for all Americans in all phases of life, and we must encourage more Americans to take that path." Treasury Assistant Secretary for Tax Policy Pamela Olson said that "these bold new initiatives will give more hardworking Americans the chance to save so they can enrich their lives and strengthen their retirement security." Although not given as an official reason, speculation has grown that the new proposal has, at least in part, been triggered by the fact that retirement assets would not share in the benefits offered by the president's proposal to make dividends tax-free.

Lifetime Savings Accounts

LSAs would allow individuals, regardless of age or income, to contribute $7,500 annually to an account that would allow them to make penalty-free withdrawals with no holding period. Much like Roth individual retirement accounts (Roth IRAs), contributions to LSAs would not be presently deductible, but the earnings and distributions would be tax-free. However, LSAs are much more flexible since the accounts could be used for any purpose. The Treasury cites education, real estate purchases, healthcare needs, or starting a new business as goals for which a taxpayer may save using an LSA. However, a taxpayer could, in fact, apply those savings to any purpose. Thus, individuals could determine when and for what reason a distribution should be made without facing any stiff "early-withdrawal" penalty.

The proposal would also allow conversion of existing savings accounts into LSAs. Under the proposal, individuals would be free to convert balances from Archer Medical Savings Accounts (MSA), Coverdell Education Savings Accounts (ESA) and Qualified State Tuition Plans (QSTP) into LSAs prior to January 1, 2004. Individuals who do not convert would still be able to contribute to these types of accounts.

In addition, while a conversion of an ESA or QSTP to an LSA would not result in taxation in the year of conversion, conversion of an MSA to an LSA would result in taxation in the year of conversion. However, if the conversion of an MSA were executed prior to January 1, 2004, the taxpayer would be allowed to spread the tax bill out over four years (similar to the spread allowed in 1998 to taxpayers who converted from a traditional IRA to the then-new Roth IRA). The proposal seeks to simplify and expand savings accounts to make them more accessible to taxpayers of all income levels.

Retirement Savings Accounts

RSAs, by contrast, could only be used for retirement savings. The proposal would consolidate and streamline traditional IRAs, Roth IRAs and nondeductible IRAs. RSAs would be subject to rules that are similar to those applied to Roth IRAs, but would allow an annual contribution of up to $7,500. Earnings and distributions after age 58 (or upon death or disability) from an RSA would be tax-free, but there would be no front-end tax deduction for contributions. There would also be no income restrictions for RSA eligibility. Current law phases out Roth IRA eligibility for single and joint filers earning in excess of $95,000 and $150,000, respectively.

Existing Roth IRAs would simply be renamed as RSAs, but taxpayers would be allowed, not compelled, to convert traditional and nondeductible IRAs to RSAs. However, individuals would no longer be able to contribute to traditional or nondeductible IRAs.

Conversions from traditional IRAs could be done at any time, but would be taxable except to the extent that there is basis in the IRA. Individuals also would be able to contribute to both LSAs and RSAs at the same time, allowing a total of $15,000 of contributions to both accounts annually. In addition, LSA and RSA contributions could be made on behalf of any other individual up to the $15,000 limit. Married couples filing jointly would be entitled to contribute $7,500 each to an RSA.

Dallas Salisbury, President and CEO of the Employee Benefits Research Institute (EBRI), expressed doubt over claims that, if enacted, RSAs will increase retirement savings. Salisbury observed that, for most taxpayers, the LSA would be the first place individuals would put their money. Since the LSA limit is $7,500, and that is more than most taxpayers save annually, the LSA would absorb retirement savings, resulting in a decrease in such savings. However, Salisbury indicated that allowing taxpayers greater access to their savings, as LSAs would do, could increase total savings, but most taxpayers would still not save more than $2,000 annually.

Employer Retirement Savings Accounts

The ERSA proposal represents an attempt to simplify the complexities of the employee benefit program so that employers would be encouraged to offer retirement plans to employees. Beginning in 2004, all Code Sec. 401(k) plans would be renamed ERSAs, but SIMPLEs, SARSEPs, Code Sec. 403(b) and Code Sec. 457 plans would continue on indefinitely, although no further contributions could be made to those plans.

Generally, the ERSA rules would mimic current rules for Code Sec. 401(k) plans, but would be much simpler. Under the ERSA proposal, the definitions of compensation and minimum coverage would be simplified and the top-heavy rules would be repealed. The nondiscrimination requirements for ERSA contributions would be satisfied using only a single test, but employers could also adopt a design-based safe harbor to avoid that test.

Under the ERSA proposals, employees would be able to defer $12,000 annually and could also make after-tax contributions to an ERSA. After-tax contributions would be treated like contributions to an RSA.

The Treasury Department estimates that only 50 percent of workers participate in employer-sponsored retirement plans. The proposed ERSA rules would not only simplify the employee benefit program, but would also reduce compliance costs, making employee benefit plans more attractive to employers. As Olson noted, "because employer sponsorship is voluntary, the complexity discourages many employers from offering any plan at all. I am confident that simpler rules will encourage employers to create new plans for their employees."

Salisbury also disputes the position that the proposed ERSAs would encourage smaller employers to offer pension plans. According to surveys conducted by EBRI, smaller employers do not offer pension plans because they lack sufficient profitability to match employee contributions, not because of complexity, as the Bush administration contends. EBRI's research found that employees were more likely to participate in a pension plan if the employer offered a matching program.

Ways and Means Members Response

The president's proposal received a chilly reception from Rep. Charles B. Rangel, D-N.Y., the ranking Democrat on the House Ways and Means Committee. The plan would help wealthy Americans shelter their money from taxes through vast tax breaks, argued Rangel. While Bush claims the new accounts would promote savings, Rangel said that they would just allow affluent Americans to shift around money they already save. Lowering federal deficits would be the best way to promote saving, he added.

"For the White House, tax cuts are first in war and first in peace and the solution to every political problem. In this case, some of their supporters were feeling left out by their other tax break proposals, and so they upped the ante, "said Rangel in a written statement. "The result will be a transfer of more of the tax burden from the wealthy to the middle-class," he said.

However, House Ways and Means Committee member Rob Portman, R-Ohio, believes the plan could be a positive first step toward simplifying the system of retirement security, according to Portman's Press Secretary Jim Morrell. Portman has worked on this goal for years, Morrell told CCH. Portman introduced a number of pension reform measures in the 107th Congress such as the Protecting America's Savings Bill of 2002 (HR 5553). Included in that bill was a proposal to expand contribution limits to $5,000 for IRAs and $15,000 a year for Code Sec. 401(k) plans (TAXDAY, 2002/10/04, C.5).

By Dave Hansen and Daniel Rinke, CCH News Staff

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