Editor's note: Got a question you'd like to ask about sectors, companies or issues affecting the markets? Email us at email@example.com, and one of our reporters will track down an expert. In today's "Ask the Expert," personal-finance writer Beverly Goodman explains how proposed tax-free savings plans would work.
With a surprisingly good economic quarter in its pocket, the White House is resurrecting a piece of its fiscal initiative for President Bush's re-election campaign: tax-free savings.
First touted back in January as part of President Bush's proposed budget, these tax-free savings accounts would include virtually no restrictions -- no income caps and minimal 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 initial budget proposal would have created 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
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 Unlike Roth IRAs, there would be no holding periods, age requirements or restrictions on what the money is withdrawn for.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.)
In addition, the new accounts would help only investors who have the $7,500 to $30,000 a year to invest. Because the proposal eliminates deductible IRAs, low-income taxpayers who need a tax break
to encourage savings (when the money is contributed, rather than withdrawn) actually will be worse off.
The administration shelved these breaks when mounting opposition in Congress made it clear they would never be included in the budget. President Bush instead focused on pushing through other tax breaks for investors -- most notably the capital gains cut and reduced tax on equity dividend income.
In response to issues raised by Congressional dismissiveness of these accounts, the White House will likely tweak the plan a bit. It is considering restricting new contributions to these accounts -- essentially phasing out Roth IRAs, traditional IRAs and educational and medical savings accounts.
The rules governing these existing accounts would likely remain unchanged; new money would simply be funneled into the LSAs and RSAs.
Also, to counter the arguments that these accounts favor the rich, the White House is considering including a provision that would expand government matches for low-income savers.