Lifetime Savings Accounts A Dramatic Proposal
By: M. Eileen Dorsey
The U.S. is looking at changing the way Americans can save for retirement. M. Eileen Dorsey, of Money Consultants Advisory, Inc., examines the proposal for Lifetime Savings Accounts.
The concept of Lifetime Savings Accounts is part of a three-fold proposal to enhance savings in the U.S. by changing retirement savings as well as non-retirement savings.
If enacted into law, not only would a new and very revolutionary unrestricted means of savings be created, but it would also reduce the restrictions and increase the contribution limits to existing retirement accounts such as ROTH IRAs, 401(k)s, and other employer-based retirement plans.
The most dramatic change is the proposal for Lifetime Savings Accounts. It would allow each individual, regardless of age or income, to establish a Lifetime Savings Account. Each individual would be allowed to contribute up to $7,500 per year on an after-tax basis into his or her own account. It would also allow other individuals to contribute to the same account regardless of their age, income, or relationship to the account owner. The only restriction is that the maximum annual contribution per individual account would be capped at $7,500.
Although not tax deductible upfront, these accounts are very tax friendly. Earnings would accumulate tax-free and, most importantly, all distributions would be taxfree regardless of how and when the money is withdrawn or spent. The money could be withdrawn at any time or kept in the account indefinitely.
The second part of the proposal is called Retirement Savings Accounts. These accounts would operate similar to the current ROTH IRA with fewer restrictions, a higher annual contribution limit, and absolutely no required minimum distributions.
Similar to the Lifetime Savings Accounts, the annual contribution limit would be $7,500 on an after-tax basis, but the contribution amount would be limited to an individual’s earned income. No other income or age limits would apply. However, individuals would only be allowed to contribute to their own account and not to the accounts of others.
Similar to the Lifetime Savings Accounts, earnings would accumulate taxfree and qualified distributions after age 58, or in the event of death or disability, would be tax-free. However, normal distributions prior to age 58 would be considered nonqualified distributions. These distributions would be taxed and subject to a premature withdrawal penalty to the extent the withdrawal exceeded the cost basis.
Under the proposal, the Retirement Savings Accounts would continue to play a significant role in retirement savings because existing balances in IRAs, 401(k)s, pension plans, and other retirement accounts could be rolled into these accounts or traditional IRA accounts. Current ROTH IRAs would be renamed Retirement Savings Accounts.
Individuals could keep existing traditional IRA accounts, but they could not make any new annual contributions to these accounts after the effective date. Individuals would also be allowed to convert existing traditional IRA balances into Retirement Savings Accounts by paying taxes on the taxable amount over a period of time as specified in the law. This would work very similar to the current traditional IRA to ROTH IRA conversion except that it would be available to anyone because no income limits would apply to the ability to convert.
Additionally, new traditional IRAs could be created to accommodate rollovers from employer plans. Or individuals could choose to roll these amounts directly to a Retirement Savings Account by paying taxes on the taxable amount over a period of time as specified in the law.
The third part of the proposal is called Employer Retirement Savings Accounts. These accounts would consolidate and simplify existing employer-based plans such as 401(k) plans, 403(b) plans, 457 plans, SIMPLEs, and SARSEPs. The topheavy and non-discrimination rules would be simplified which should effectively simplify administration and reduce employer costs. These accounts would allow employees to contribute up to $12,000 of compensation ($14,000 if age 50 or older) on either a before-tax or, if the plan allows, an after-tax basis.
The Employer Retirement Savings Accounts would also continue to play a significant role in retirement savings because it is employer-based, payroll-deducted, and tax-deductible. From a psychological standpoint, most people save more if they get a tax benefit and are more likely to save if the savings are put on auto-pilot such as with payroll deduction.
The changes to the Retirement Savings Accounts and Employer Retirement Savings Accounts primarily involve eliminating income restrictions and required minimum distributions, increases to the contribution limits, and, hopefully, increased access to small employers due to simplification and consolidation of employer-based plans.
The two primary advantages of the Lifetime Savings Accounts would be that anyone can contribute to an individual’s Lifetime Savings Account regardless of the owner’s earned income or lack thereof and the Lifetime Savings Accounts would have absolutely no withdrawal restrictions. They could be used for a myriad of reasons including – but not limited to – retirement savings, saving for a new or more expensive home, college funding, saving for future health care costs, or estate planning from one generation to another. They could also be used as simple tax-free savings accounts.
From a financial planning standpoint, the Lifetime Savings Account offers the most flexibility for retirement savings as well as other savings goals. It will force everyone to eventually rethink their saving strategies. I would see that fully funding Lifetime Savings Accounts would come first for most people and then, if an individual can save more for themselves and their family members, funding either the Retirement Savings Account or the Employer Retirement Savings Account depending upon availability and an individual’s circumstances. Some people will use the Lifetime Savings Account as a short-term savings vehicle.
U.S. employers, if and when some version of the proposal becomes law, will have to decide if and how they should revamp their current employer-funded and employer-based, but employee-funded savings, options. If they currently have an employer-based Defined Contribution plan, such as a 401(k), they will probably keep that. Changing from a 401(k) to the new Employer Savings Retirement plan should be somewhat simple. Employers might even be able to reduce administrative costs due to the proposed simpler structure of the plan.
The difficult part will be deciding if they should enhance their employer-based savings options. Some of the questions to explore include:
- Do employers have a responsibility or do they want to take responsibility to help employees save for retirement?
- Should employers be in the business of helping employees save for retirement or should they get back to what they do best – their basic business?
The Lifetime Savings Account proposal certainly indicates a definite continuing trend in the direction of individuals taking more responsibility for their own savings and retirement income. This is a positive for employers. It will relieve some of the responsibility for an employee’s retirement income and potentially reduce the employer’s liability in this area. After all, they are not in the business of managing money or being responsible for their employee’s retirement savings. Most simply got into this business because of the introduction by Congress of the 401(k) that had to be employer-based, competitive forces, and collective bargaining.
The big question is ‘should employers offer access for the Lifetime Savings Accounts?’
Let’s think back to the main reason why employers offer 401(k)s in the first place. The answer is to attract and retain good employees. So the decision about whether or not to offer an employer-based Lifetime Savings Account will be based primarily on what the competition does. Will an employer need to offer this as part of a benefit package to attract and retain highly skilled employees? Other considerations will include:
- What are the costs of establishing and administering an LSA?
- Does it make sense to offer the LSA as a workplace benefit?
- If employees have access to unrestricted LSAs, do they need the company to offer payroll deduction to help them save?
- Is this a benefit workers will demand or maybe not even want?
- What would the utilization be?
- Would employers be allowed, or could they afford, to offer an employer match on these accounts in addition to the other employer-matched or funded accounts?
- Would they want to allow non-employees to fund the account of employees?
- Would this be an administrative nightmare?
- How much can your average worker afford to save for retirement? The average worker saves less than $7,500 per year, so if they fund the LSA first would they continue to fund the 401(k) or its replacement, the Employer Retirement Savings Account?
- Would the reduced utilization of the 401(k) or its replacement, the Employer Retirement Savings Account, affect a company’s bottom line or ability to attract and retain highly skilled employees?
- Should an employer establish an LSA that might be used primarily by higherincome workers? Or would these workers prefer to fund these accounts outside of the workplace to increase investment diversification?
- Would establishing an employer-based LSA increase liability? If the proposal passes as is, it may make more sense to modify current benefit packages to comply with the new laws and take a wait-and-see attitude to determine what the competition does and what the employees want.
In the meantime, employers should benefit from the simpler structure and reduced administrative costs of the plans that they already offer. Employers might think about using some of this to give employees access to retirement savings education that they so desperately need.
Most employees need to be educated on both a group basis about investments – and how much they need to save in general – and, on an individual basis, about asset allocation, how much their family needs to save based on individual circumstances, and how to save it. Group education is fairly inexpensive. Individual counseling is more costly and companies might want to use the first $300 or so of the company match in the new Employer Retirement Savings Accounts for individual financial counseling.
The one certainty is if the concept of Lifetime Savings Accounts does, in fact, become law in the U.S., it will change the way people save for everything, not just retirement.
M. Eileen Dorsey is author of LIFETIME STRATEGIES: How To Achieve Your Financial Goals, and president of Money Consultants Advisory, Inc. and Money Consultants Services, Inc.
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