Saving for a lifetime: New accounts part of Bush’s tax plan." That exact headline ran in this paper last April. The article under the headline described the two new savings accounts President Bush proposed in January 2003: lifetime savings accounts (LSAs) and retirement savings accounts (RSAs). Neither proposal made it through Congress.
Well, they’re back, even with the same acronyms. President Bush proposed RSAs, LSAs and other tax savings proposals in the budget sent to Congress earlier this year. The Democratic leadership says the LSAs and RSAs will not pass this year, either, but informed savers may want to start planning. Here are the guidelines:
— Each taxpayer can contribute $5,000 annually beginning in 2005.
— There is no income tax deduction for the contribution.
— There is no age or income limitation on who is eligible.
— Contributions can be made even if the account holder has no earned income.
* Withdrawals can be made at any time for any purpose without payment of federal income tax.
–As with LSAs, taxpayers can contribute $5,000 annually beginning in 2005, there is no income tax deduction for the contribution and there is no age or income limitation on who is eligible. RSA contributions cannot exceed earned income.
— Only withdrawals after age 58, death or disability would be free of federal income tax. Withdrawals before age 58 would be subject to a penalty as well as income tax.
LSAs and RSAs offer single taxpayers the opportunity to save up to $10,000 annually with all future growth tax-free. For married couples, the annual savings opportunity could equal $20,000.
While waiting for the fate of President Bush’s proposals, savers should make sure they are taking full advantage of tax savings opportunities currently available. Analysts estimate that 90% of taxpayers do not take full advantage of the tax-qualified savings plans already in place.
Most people with earned income qualify for employer-sponsored plans such as 401(k)s. Wage earners should contribute to those plans to the fullest extent possible before considering other savings plans, particularly if employers match contributions. President Bush’s latest proposals include a plan to replace the wide variety of employer-provided retirement plans with one plan similar to a 401(k).
Less well-known are the medical savings accounts (MSA) authorized by legislation signed last fall. These accounts allow taxpayers with high deductibles on their health insurance plans to put away as much as $5,150 (for a married family) a year. The MSA can be used to pay medical expenses, excluding health insurance premiums. Once the IRS issues guidance on some of the finer points, MSAs should start to become available. The IRS rules are expected in June.
Section 529 education savings plans have received much attention in the past few years. Section 529 plans follow the approach similar to the LSAs and RSAs: no deduction is allowed for the contribution. A distribution is tax-free if used for higher education.
Under President Bush’s proposal, Section 529 plans will continue to be available, but with some additional provisions. Existing Section 529 plans can be converted to LSAs. Section 529 plans can be offered as part of LSAs subject to the LSA contribution limit. States can provide state tax benefits for LSAs offered as part of Section 529 plans.
President Bush’s proposal, if enacted, would become effective in 2005. Traditional rules governing contributions to traditional IRAs, Roth IRAs, and other tax-advantage plans continue to apply in 2004. Under President Bush’s plan, traditional IRAs and Roth IRAs will be frozen.
However, those accounts could be converted to a RSA. Distributions to traditional IRAs are presently eligible for an income tax deduction. Contributions to an RSA do not generate an income tax deduction. The benefit of the RSA is that the money will come out income tax-free when withdrawn in the future. The experts expect that the tax-free withdrawal will yield more money available to the IRA owner than the current system.
There are parts of President Bush’s proposed tax changes that focus on alternative minimum tax ("AMT") and charitable deductions. The alternative minimum tax is designed to require high-income taxpayers pay a minimum income tax regardless of what deductions or other tax benefits they may be eligible for.
The law does not adjust the AMT exemption to keep up with inflation. Every year, more taxpayers are finding themselves subject to AMT, particularly in states like Wisconsin with a high state income tax. Finally, the Bush proposals would allow taxpayers who do not itemize deductions to deduct charitable contributions to the extent that the contributions exceed certain thresholds.
Sally C. Merrell is a partner in the Milwaukee law office of Quarles & Brady.
April 2, 2004 Small Busienss Times, Milwaukee