Tax-Free Savings! Is That Good?

The Treasury Department is already touting what's sure to be the controversial centerpiece of President Bush's new budget: tax-free savings.

The tax-free savings accounts would include virtually no restrictions -- no income caps or age requirements.

The plan rests on the premise that investment income should not be taxed. And while the administration is promoting it as a way to help all Americans save, it not surprisingly benefits the wealthy more than lower-income individuals.

The first budget proposal would create two new consolidated savings accounts: Lifetime Savings Accounts (LSAs) and Retirement Savings Accounts (RSAs). Not only would individuals be able to contribute up to $7,500 a year to these accounts regardless of their income or age, but the proposal also includes a provision that would allow individuals to transfer existing accounts into these new accounts. There would be no restrictions on the money's withdrawal.

As with Roth IRAs, contributions would be after tax (in other words, contributions are not deductible), but all withdrawals would be tax-free -- including earnings on your contributions. Unlike Roth IRAs, there would be no holding periods, age requirements or restrictions on what the money is withdrawn for.

Money in LSAs could be used for absolutely anything. RSAs would be specifically for retirement, and withdrawals of earnings would be tax-free only after age 58. The proposal would let individuals contribute the maximum amount to each account every year -- so each investor could contribute up to $15,000 ($30,000 for married couples) a year to these new accounts.

These accounts wouldn't do much for the vast majority of Americans who earn less than $100,000 a year -- they would primarily benefit investors who are not able to benefit from current income-capped tax breaks. For instance, Roth IRAs, which these accounts are modeled on, start to limit contributions when individual income reaches $95,000 and when a couple's income reaches $150,000. (Contributions are fully phased out and not allowed when individual income reaches $110,000 and joint income hits $160,000.)