030203 Tresuary Dept. Press Release
Presidentfs Budget Proposes Bold Tax-Free Savings and Retirement
Security Opportunities for All Americans
gAmericans can help secure their own future by saving. Government must
support policies that promote and protect saving. And saving is the path
to independence for Americans in all phases of life, and we must encourage
more Americans to take that path.h -President George W. Bush
Today
the Treasury Department announced that the Presidentfs Budget will include
two bold new expanded savings proposals covering all Americans.
The first creates two new consolidated savings accounts: Lifetime
Savings Accounts (LSAs) and Retirement Savings Accounts, (RSAs) that will
allow everyone to contribute -- with no limitations based on age or income
status. Individuals will be able to convert existing accounts into these
new accounts in order to consolidate and simplify their savings.
gThese bold new accounts will give more hardworking Americans the
chance to save so they can enrich their lives and strengthen their
retirement security,h stated Treasury Assistant Secretary for Tax Policy
Pam Olson. gThey make saving simple for everyone and for every purpose. No
longer will individuals have to worry about the confusing alphabet soup of
six different savings accounts. No longer will people have to worry about
the endless maze of confusing rules. The two simple accounts will have one
powerful goal -- making saving for everyday life and retirement security
easier and more attractive.h
The second proposal creates Employer
Retirement Savings Accounts (ERSAs) to promote and vastly simplify
employer sponsored retirement plans by consolidating 401(k), SIMPLE
401(k), 403(b), and 457 employer-based defined contribution accounts into
a single type of plan that can be more easily established by any employer.
Lifetime Savings Accounts
Lifetime Savings Accounts (LSAs)
can be used for any type of saving. LSAs will help millions of Americans
save in one tax favored account for any purpose, including their
childrenfs education, a new home, healthcare needs, or to start their own
business. The new LSA will allow an individual, regardless of age or
income, to contribute $7,500 a year and make penalty free withdrawals at
any time -- with no holding period. Like current law Roth IRAs,
contributions will not be deductible but earnings will accumulate
tax-free, and distributions will be tax free as well. Unlike current
education accounts and MSAs, with LSAs, taxpayers will not need to
carefully anticipate future qualified expenses and allocate savings among
tax-preferred accounts. Taxpayers will not be required to document
qualified expenses, financial institutions will not need to explain
complicated rules to participants, and the government will not need to
verify the qualifying expenses.
Prior to January 1, 2004,
individuals may convert balances in an Archer Medical Savings Account
(MSA), Coverdell Education Savings Account, and Qualified State Tuition
Plan to LSAs. Balances in these accounts may not be converted to LSAs
after 2003.
The $7,500 contribution limit will be indexed for
inflation in future years.
LSA's are good for average Americans
because:
• They can simply save more tax free.
• More low
and moderate-income taxpayers will participate. Many do not participate
now because they are more likely to face a penalty if they need the funds.
Knowing they can access the money at anytime for any purpose will
encourage them to set money aside and allow them to receive tax-free
earnings from their first dollar of savings..
• It takes away the
hassle factor. The combination of universal eligibility and unrestricted
tax-free withdrawals greatly simplifies the whole process, making it more
likely that average taxpayers will participate, especially inexperienced
savers. Many low- and moderate-income taxpayers will conveniently be able
to put all their financial assets in one place; this will greatly simplify
their taxes because they will no longer receive taxable investment
earnings.
Retirement Savings Accounts
Retirement Savings
Accounts (RSAs) can be used only for retirement saving. The new RSA will
improve and simplify savings opportunities for all Americans by
consolidating traditional IRAs, nondeductible IRAs and Roth IRAs, each of
which has a confusing and different set of rules regarding eligibility and
tax treatment, into one streamlined type of account with rules similar to
current law Roth IRAs. Up to $7,500 (in addition to amounts contributed to
an LSA) could be contributed to an RSA. Like current law Roth IRAs,
contributions will not be deductible but earnings will accumulate tax free
and distributions after age 58 (or death or disability) will be tax free.
Existing Roth IRAs will be unaffected (except that they will be
renamed RSAs). Existing traditional and nondeductible IRAs may be
converted into RSAs; those not converted to RSAs could not accept any new
contributions (other than rollover contributions); no one would be
required to convert.
The $7,500 contribution limit will be indexed
for inflation in future years.
Complex eligibility restrictions
for IRAs under current law confuse taxpayers and cause some to avoid
contributing to IRAs, even if they are eligible to contribute. IRA income
limits were imposed in 1986 greatly limiting eligibility. Studies have
shown that participation after 1986 fell among lower-income taxpayers,
even among those still eligible to make deductible contributions.
RSAs are good for average Americans because:
• More
Americans will save for retirement. Repeal of the income limits will
eliminate the confusion and complexity associated with determining
eligibility and will encourage participation.
• It makes saving
for retirement simple and easy. Individuals will not be required to make
minimum distributions from the accounts during their lifetime, simplifying
financial planning in retirement.
• More will be set aside for
retirement. Current IRAs allow for withdrawals for many non-retirement
purposes. Each withdrawal from an IRA potentially reduces retirement
funds. Having a separate retirement account will help individuals plan for
both non-retirement and retirement needs.
Employer Retirement
Savings Accounts
There are currently multiple tax-preferred,
employer-based retirement savings accounts with similar goals but
different rules regulating eligibility, contribution limits, tax
treatment, and withdrawal restrictions. The Budget proposal will
consolidate 401(k), thrift, 403(b), and governmental 457 plans as well as
SARSEPs and SIMPLE IRAs into a streamlined and simpler account, Employer
Retirement Savings Accounts (ERSAs), which can be sponsored by any
employer.
Assistant Secretary Olson stated, gThe overwhelming
complexity of current rules imposes substantial burdens on employers and
workers. Because employer sponsorship of a retirement plan is voluntary,
this complexity discourages many employers from offering any plan at all.
This is especially true of small employers who together employ about 4 out
of every 10 American workers. It's one important reason why only 50% of
working Americans have any pension plan at all. I'm confident that simpler
rules will encourage employers to create new plans for their employees
because creating a qualified plan will be much easier.h
ERSAs will
follow the existing rules for 401(k) plans, but these rules will be
greatly simplified. For example, both the definition of compensation and
the minimum coverage requirement will be simplified and the top heavy
rules will be repealed. Nondiscrimination requirements for ERSA
contributions will be satisfied by a single test and many firms may choose
to adopt a new designed-based safe harbor to avoid this test altogether.
The proposal simplifies qualification requirements while maintaining their
intent of providing broad-based coverage of employees. By reducing
unnecessary complexity, the proposal significantly reduces employer
compliance costs.
Complexity and the associated compliance costs
are often cited as a reason the coverage rate under an employer retirement
plan has not grown above about 50 percent overall, and has remained under
25 percent among employees of small firms. Firms that are currently not
offering retirement plans because of compliance costs will be more likely
to offer such plans under the proposal, increasing coverage and
participation.
ERSAs are good for workers because:
•
Coverage and participation will increase because firms that are not
currently offering retirement plans because of the complexity and
compliance costs will be more likely to offer such plans under the
proposal.
• More small businesses will be able to cover more
workers. The reduction in red tape will remove a barrier that discourages
small business owners from offering this benefit to their employees. Small
businesses employ about two-fifths of American workers, but the pension
coverage rate has consistently remained under 25 percent among employees
of small firms.
• Employees will benefit because firms currently
offering employer plans will have reduced compliance costs.
Frequently Asked Questions Regarding the LSA/RSA and ERSA
Proposals
LSA/RSA Provisions
I have been
contributing to IRAs for years. Will I have to stop?
After
2003, you will no longer be able to contribute to an IRA. However, your
ability to contribute to both an LSA and an RSA will give you much more
flexibility to save for your future. You will be able to save up to $7,500
(indexed in the future for inflation) in an LSA plus up to $7,500 (indexed
in the future for inflation) in an RSA for a total of $15,000 in
tax-preferred savings. In addition, you will have much more flexibility to
take distributions for what you deem appropriate when you deem it
appropriate.
Will there be any income limitations on making
contributions to LSAs or RSAs?
There are no income
limitations on making contributions to LSAs. You can make a contribution
to an LSA even if you have no wage income. Thus, you can make
contributions on behalf of your children or other family members, in order
to help them save for home ownership, health emergencies, education,
retirement, or other future costs. While there are no maximum income
limitations on making contributions to RSAs, you may not contribute more
than your compensation (wages) income to an RSA.
What tax
benefits do I receive if contributions are not deductible?
While all contributions to LSAs and RSAs will be nondeductible,
all distributions from LSAs and RSAs (except for RSA distributions prior
to age 58, death or disability) will be excludible from taxable income. As
a result, all investment earnings can be distributed tax free. This is the
same tax treatment as current law Roth-IRAs.
Which tax
treatment would be better for me: an old-style deductible IRA or a new
Roth-style RSA?
For the vast majority of individuals it
doesnft make a difference: After-tax income in retirement is the same
whether contributions are tax free and distributions are taxed or
contributions are taxed and distributions are tax free. The only
exceptions to this rule are individuals who change tax brackets after they
retire. If an individualfs tax rate declines in retirement, deductible
contributions are better; if an individualfs tax rate increases in
retirement, Roth treatment is better.
Will I continue to be
able to contribute to Archer medical savings accounts, Coverdell education
savings accounts and qualified state tuition programs?
Yes. The LSA/RSA proposal will not affect your ability to
contribute to MSAs, ESAs, or QSTPs. Many taxpayers may prefer the
increased flexibility of the new LSAs as their tax-preferred savings
vehicle.
Can I convert my existing IRAs, MSAs, ESAs, and
QSTPs to an LSA or RSA?
You may convert an MSA, ESA, or
QSTP to an LSA anytime before January 1, 2004. In the case of a conversion
of a QSTP or ESA, no amount would be taxable in the year of the conversion
while a conversion of an MSA to an LSA will result in taxation of the
total amount converted in the year of the conversion.
You may
convert a traditional IRA to an RSA at any time. The amount converted will
be taxable except to the extent that you have basis in your IRA. If you
convert prior to January 1, 2004, you will be able to spread the tax on
the conversion over a four-year period. For conversions on or after
January 1, 2004, the total taxable amount will be included in your gross
income for the year of the conversion.
Will the Saverfs
Credit still be available after the enactment of the LSA/RSA
proposal?
Yes. The Saverfs Credit will be available for
elective deferrals and LSA/RSA contributions made prior to 2007.
What will happen to the new deemed IRA provision? Will
employer plans still be able to offer them?
Deemed IRAs
will become deemed RSAs and will be subject to the rules applicable to
RSAs.
Who will be able to become trustees for the LSAs and
RSAs?
The rules that now apply to IRAs regarding who can
be a trustee will apply to LSAs and RSAs. Thus, the trustee will have to
be a bank or another person who demonstrates to the IRS that the manner in
which they will administer the trust will be consistent with the rules
applicable to LSAs and IRAs.
Will LSAs and RSAs be permitted
to be held in the form of an annuity?
Yes. LSAs and RSAs
may be held in the form of a nontransferable annuity contract issued by an
insurance company that meets the rules that currently apply to individual
retirement annuities.
Can I make LSA or RSA contributions on
behalf of other persons, such as my children or spouse?
Yes, you may make LSA or RSA contributions on behalf of any other
individual. However, total contributions made on behalf of an individual
may not exceed $7,500 for LSAs and $7,500 (or compensation income, if
less) for RSAs. In the case of a married couple filing jointly, RSA
contributions up to $7,500 can be made for each spouse (including, for
example, a homemaker who does not work outside the home) if the combined
compensation of both spouses is at least equal to the contributed amount.
Will catch-up contributions be available for LSAs or
RSAs?
Catch-up contributions will not be available for
LSAs or RSAs, but the limits applicable to all individuals in LSAs and
RSAs will be significantly greater than the existing IRA limits, even with
catch-up.
ERSA Provision
Which types of
employer-sponsored plans would be replaced by the new ERSA?
The ERSA would replace all types of funded plans with employee
contributions. Thus, ERSAs would replace 401(k) plans, SIMPLE 401(k)
plans, 403(b) plans, governmental 457 plans, salary reductions simplified
employee pensions (SARSEPs), and SIMPLE IRAs. The ERSA would not replace
nongovernmental 457 plans.
Are there any types of employers
who would not be able to sponsor an ERSA?
No. Any employer
would be able to sponsor an ERSA.
Will the ERSA proposal
have any effect on the amount that an employee will be able to defer under
existing law?
The amount that an employee will be able to
defer under an ERSA will be $12,000 (increasing to $15,000 in 2006) plus,
once the employee reaches age 50, a catch-up contribution of $2,000
(increasing to $5,000 in 2006). This is the same that an employee may
defer under a regular 401(k) plan, a 403(b) plan, a SARSEP or a 457 plan,
but it is greater than the amount permitted under a SIMPLE 401(k) or
SIMPLE IRA.
Will after-tax contributions be permitted under
an ERSA?
Yes. After tax contributions will be permitted to
an ERSA, and accounts attributable to such contributions made after 2003
will be treated much like the new RSAs. Distributions from such accounts
will generally be exempt from taxation and the accounts will not be
subject to the required minimum distribution rules until after the death
of the participant.
Will governments with grandfathered
401(k) plans and public schools with 403(b) plans still be able to allow
deferrals up to the maximum under a 403(b) or 401(k) plan as well as the
maximum under a 457 plan?
No. Once ERSAs are in place, all
covered employees will be able to defer only the maximum applicable to
ERSAs.
Will employers have to terminate their existing plans
and transfer the assets to an ERSA?
No. Beginning in 2004,
all 401(k) plans will become ERSAs. SIMPLEs, SARSEPs, 403(b) plans, and
governmental 457 plans may continue in existence indefinitely, but may not
accept any future contributions after 2004.
What
nondiscrimination tests will apply to ERSAs?
The same
simplified nondiscriminatory coverage requirement will apply to ERSAs
(other than those covering only state and local government employees) that
will apply to all other defined contribution plans. (See Q&A below).
An ERSA will satisfy the nondiscriminatory benefit requirements if the
average contribution percentage for nonhighly compensated employees is no
greater than 6% and the average contribution percentage for highly
compensated employees does not exceed 200% of the average contribution
percentage for nonhighly compensated employees. If the average
contribution percentage for nonhighly compensated employees is greater
than 6%, then the average contribution percentage for highly compensated
employees may be any amount.
Will state and local
governments and charitable organizations be subject to the
nondiscriminatory benefit requirement?
ERSAs covering only
employees of state and local governments will be exempt from the
nondiscriminatory benefit requirement. An ERSA covering only employees of
a charitable organization will be subject to the nondiscriminatory benefit
requirement only if it allows after tax contributions. In any event, an
ERSA covering employees of a charitable organization will be subject to a
universal availability requirement regarding the ability of employees to
make deferrals under the plan. That is, all employees of the organization
must be permitted to elect to make deferrals of more than $200.
Is there a safe-harbor design under which an employer will
not be required to apply the general nondiscriminatory benefit rule
described above?
Yes. A plan can satisfy the
nondiscriminatory benefit rule through any one of the following safe
harbor employer contribution designs:
1. The employer makes a
nonelective contribution on behalf of each participant in the plan equal
to 3% of the employeefs compensation,
2. The employer makes a
matching contribution equal to 50% of each employeefs deferrals (up to 6%
of compensation), or
3. The employer makes a matching contribution
that does not increase based on the level of an employeefs deferrals and
the match is equal to the amount that would be made under a 50% match (up
to 6% of compensation), such as a match of 100% of each employeefs
deferrals (up to 3% of compensation).
Does the budget
proposal related to ERSAs affect any other defined contribution
plans?
Yes. The proposal includes the following provisions
that would greatly simplify the administration of all defined contribution
plans:
1. There would be a single test to show that the plan meets
the nondiscrimination rules with respect to coverage -- ratio-percentage
coverage. Under this test, the percentage of an employerfs nonhighly
compensated employees covered under a plan would have to be at least 70%
of the percentage of the employerfs highly compensated employees covered
under the plan. The other coverage testing alternatives would be repealed.
2. Permitted disparity and cross-testing would be prohibited for
defined contribution plans.
3. The top heavy rules would be
repealed for defined contribution plans.
4. There would be a
uniform definition of compensation for all purposes for defined
contribution plans – the amount reported on form W-2 for wage withholding,
plus the amount of ERSA deferrals.
5. A simplified definition of
highly compensated employee would be adopted under which all individuals
with compensation for the prior year above the Social Security wage base
for that year would be considered to be highly compensated employees.
Does the ERSA proposal have any effect on defined
contribution plans that do not involve employee deferrals or employee
after-tax contributions? In other words, does the proposal affect pure
profit sharing plans, stock bonus plans, and money purchase pension
plans?
Other than the simplifications discussed in the
preceding question, the ERSA proposal would not affect the rules
applicable to employer contributions to defined contribution plans, other
than safe harbor nonelective contributions or matching contributions.
Does the ERSA proposal have any effect on defined benefit
plans?
No, the proposal would not affect the rules
applicable to defined benefit plans.
# # #
FROM THE OFFICE OF PUBLIC AFFAIRS
KD-3816
U.S. Treasury Department and Internal Revenue Service
Web site: http://www.treas.gov/
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