In his State of the Union address in January, President George W. Bush proposed two new savings accounts: lifetime savings accounts (LSAs) and retirement savings accounts (RSAs).
As of March, the president’s budget was still being debated by the U.S. Congress. While political commentators analyze the wisdom of the plan and the likelihood of passage, it is not too early to think about the impact of the proposals if they become law.
Here are some important points about each of the proposed savings accounts:
— Each taxpayer could contribute $7,500 annually (the $7,500 would be indexed for inflation).
— There would be no income tax deduction for the contribution.
— There would be no age or income limitation on who is eligible.
— Contributions could be made even if the account holder has no earned income.
— Withdrawals could be made at any time for any purpose without payment of federal income tax.
— The first three points above would also apply to RSAs.
— RSA contributions could not exceed earned income.
— Only withdrawals after age 58 or death or disability would be free of federal income tax.
Lobbyists representing life insurance companies have been working to change various provisions of the President’s budget bill, including RSAs, LSAs, and the proposed tax exemption for dividends. Why? Life insurance companies sell annuities. Most annuities are purchased with after-tax dollars.
When an annuity is paid out, distributions in excess of the contributions are subject to income tax. LSAs and PSAs would be tax-exempt, not tax-deferred. Assuming the same yield and the same expense ratio, the RSAs and LSAs would provide more value to the owner than an annuity, due to the tax exemption for the distributions.
LSAs and RSAs could also affect the tax-exempt municipal bond industry, as LSAs and PSAs would provide alternatives to a tax-exempt bond or bond fund.
LSAs and RSAs would offer single taxpayers the opportunity to save up to $15,000 annually, with all future growth tax-free. For married couples, the annual savings opportunity could equal $30,000.
The absence of any earnings requirement for the LSA would make this an opportunity for grandparents and family members to make gifts to young children.
Section 529 plans and other tax favored education accounts will still be available. The LSA would provide another option attractive to those who want to maximize investment control and flexibility on spending the distributions. Some commentators are concerned that the flexibility of the LSA would be too great. Instead of using LSAs to save for retirement, disability and education, taxpayers instead may use the account for short-term consumption.
The RSAs would consolidate retirement savings. Existing Roth IRAs would be unaffected, except for a name change. Traditional IRAs could be converted to RSAs (with payment of income tax). If the RSAs become law, unconverted traditional IRAs cannot receive any additional contributions, other than rollover contributions.
Until the legislation is finalized, it is too early to take specific action. If the RSAs and LSAs appear attractive to you, hold off on investments with back-end surrender charges that will make it difficult to use the funds for an LSA or RSA in the future.
If the proposals become law, then it will be time to do a specific analysis of the benefits of the RSAs and LSAs, compared with other options. Wait and make sure that Wisconsin adopts the federal changes.
Traditionally, Wisconsin, like most states, amends its laws to track changes to the Internal Revenue Code. This year might be different. Wisconsin has severe budget shortfalls. If significant cuts are made at the federal level, it’s not automatic that Wisconsin would adopt them.
Sally Merrell, a partner with Quarles & Brady in Milwaukee, is the immediate past chair of the Real Property, Probate and Trust Law Section of the State Bar of Wisconsin.
April 4, 2003 Small Business Times, Milwaukee