President Bush's plans to radically change the way Americans save for retirement offer many interesting proposals, due to their simplicity and their availability for all. But it remains to be seen whether Congress will pass these sweeping changes into law.
The administration has proposed three types of tax-advantaged savings plans going forward: a Lifetime Savings Account (LSA), a Retirement Savings Account (RSA) and an Employer Retirement Savings Account (ERSA).
The LSA proposal, available to all Americans, would allow contributions up to $7,500 per year, indexed for inflation. A married couple could put in up to $15,000 annually. No income limits would apply to this account and contributions could be made on behalf of others such as children or grandchildren. Funds going in would be after tax, but earnings and money coming out would be tax-free. Money could be withdrawn at any time and for any reason without a penalty.
The RSA option would replace today's traditional Individual Retirement Accounts (IRAs) and Roth IRAs. Like the first option, all Americans could contribute $7,500 per year ($15,000 for a married couple), indexed for inflation. After-tax money would be contributed, but after age 58, account owners could withdraw their money tax-free. The funds would also be available at death or disability.
Generally, the RSA's would resemble Roth IRAs but would eliminate some of the current restrictions. Right now, Roth IRAs carry an income limitation of $110,000 per year for a single person, and $160,000 per year for a married couple. This plan would abolish that income barrier. In addition, funds invested in traditional IRAs are taxed at retirement, whereas in a Roth IRA, contributions are after tax but earnings accumulate and qualified distributions are made on a tax-free basis. The Retirement Savings Account would function more like a Roth in this regard.
Just Call it a 401(k)
The Employer Retirement Savings Account, the third option, would replace and consolidate all of today's current employer-sponsored retirement options such as 401(k)s, 403(b)s, 457 plans, Simple IRAs and Salary Reduction Simplified Employee Pensions. The resulting plan, which all employers could offer, would look a lot like a 401(k). Funds invested could be pre-tax, after-tax or after-tax Roth contributions with earnings and distributions free of taxes. Contribution limits would mimic what we have now: $13,000 per year in 2004, moving up annually to $15,000 per year in 2006.
The so-called 401(k) catch-up provisions, allowing people over 50 to sock away more for retirement, are also part of the proposed plans. In 2003, a participant over 50 can set aside an additional $2,000 per year in their 401(k). That figure is scheduled to increase to $5,000 annually in 2006. Those provisions would all stay in place under the newly proposed approach.
Certainly, the new rules would simplify employer retirement accounts, as the administration is seeking to do. They would repeal the "top-heavy rules" currently in place that can discourage small employers from adopting a retirement plan in the first place. In addition, coverage and discrimination tests as well as new safe harbor rules would all be less complex.
There are pros and cons to each of these three options, so now it's up to Congress to weigh the many competing interests here. For instance, if the LSA is enacted, people might indeed save more, but because of greater access to their money, savings dollars might be at risk. Also, even though the elimination of top-heavy rules discussed above would be beneficial for smaller employers, the availability of a LSA and/or a RSA might discourage them from adopting a corporate retirement plan to begin with. The beauty of 401(k) and similar plans is that saving money is automatic and often matched.
Under these proposals, Americans could contribute to all three options. However, even in traditional 401(k) plans that already have tax advantages, many eligible people don't invest at all.
New York Life Investment Management's (NYLIM) retirement clients do well by industry standards, but as of November 2002, an average of 24% of our clients' employees still don't participate in their company's 401(k).
It is too early to assess how much of this plan will be passed and how much will become fodder for the Congressional circular file. The proposals are not as simple as they first appear. There are many controversial aspects that need to be addressed before any legislation is enacted.
Mark Niziak is Director of ERISA/Consulting Services at New York Life Investment Management LLC (NYLIM) Retirement Plan Services. He has consulted on all aspects of employee benefit plans and has been a lecturer at numerous employee benefit seminars. Mr. Niziak is a member of the American Bar Association and the Employee Benefits and ExecutiveCompensation Committee of the ABA.
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