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Changes in Store for IRAs and Traditional Retirement Plans

As President Bush Enters Second Term, CCH Outlines Proposed Changes

(RIVERWOODS, ILL., January 2005) – With President George W. Bush heading into a second term backed by Republican majorities in both the House and Senate, the Administration’s proposed overhaul of the country’s retirement and IRA plans are a step closer to reality, according to CCH INCORPORATED (CCH), a leading provider of tax and accounting information, software and services (tax.cchgroup.com).

Under the Administration’s proposal, first submitted by the U.S. Treasury in 2003 and subsequently modified for the 2004 proposal, four types of tax-advantaged retirement plans would be adopted:

• Retirement Savings Accounts (RSAs) – all types of IRAs would be consolidated into these Roth IRA-like arrangements;

• Lifetime Savings Accounts (LSAs) – offering tax-deferred non-retirement savings vehicles;

• Employer Retirement Savings Accounts (ERSAs) – consolidating employer-sponsored plans that use elective deferrals, such as 401(k) plans, SIMPLE plans, 403(b) tax-sheltered annuities, Salary Reduction SEPs and governmental 457 plans; and

• Individual Development Accounts (IDAs) – aimed at providing lower-income individuals opportunity to save more.

"As these proposals wind their way through Congress, further modification is very likely. The proposals do shed light on the starting point of the retirement and savings reform discussion, but we will have to see how the debate shakes out before defining the end product," said CCH Senior Pension Law Analyst Nicholas Kaster, JD, adding that Congress is likely to pick this up early in the President’s second term.

Under the President’s proposal, the three current types of IRAs – traditional IRAs, nondeductible IRAs and Roth IRAs – would be streamlined into Retirement Savings Accounts (RSA). Up to $5,000 could be contributed to an RSA with the limit indexed for inflation in future years. There would be no maximum annual income limits on making contributions to RSAs, but an individual would not be permitted to contribute more than his or her compensation (earnings includible in gross income) for the year to an RSA. Married individuals could roll over amounts from their RSA to the RSA of their spouse.

The new RSAs would share many characteristics of Roth IRAs. For example, contributions to RSAs would not be deductible, but earnings would accumulate tax-free and "qualified" distributions of earnings would also escape tax and penalties. As with Roth IRAs, distributions would be deemed to come from basis first, so an amount equal to contributions can be withdrawn without tax consequences. Also like Roth IRAs, no minimum distribution rules would apply.

"Qualified" distributions, which would be totally tax-free, could be made after age 58 – a change from the current 59½ age test for Roth distributions. Disability and death would also be "qualifying" events, but a withdrawal for the purpose of purchasing a first home would not be, as it is with Roth IRAs. Non-qualifying distributions of earnings would be subject to a 10-percent penalty as well as ordinary income tax.

Existing Roth IRAs would automatically become RSAs. Holders of current Roth IRAs would likely have until 2008 to take advantage of a penalty-free withdrawal for first-time home purchases. Holders of existing traditional and non-deductible IRAs could convert them into RSAs by including previously untaxed contributions and earnings in their income, similar to the current rules for conversions to Roth IRAs. However, unlike current rules that limit Roth IRA conversions to individuals and couples filing jointly with adjusted gross income of $100,000 or less, no income limit would apply to the ability to convert traditional and non-deductible IRAs to RSAs.

As currently proposed, Lifetime Savings Accounts (LSA) would allow an individual, regardless of age or income, to contribute up to $5,000 a year to a savings account. The contributions would be nondeductible, but earnings would accumulate tax free. All distributions would be excluded from gross income regardless of the individual’s age or use of the distribution. The $5,000 contribution limit would be indexed for inflation in future years. No minimum required distribution rules would apply throughout the LSA owner’s life.

Married individuals could roll over amounts from their LSA to the LSA of their spouse and individuals would be permitted to make contributions to the accounts of other individuals, subject to the annual aggregate contribution limit of $5,000.

Individuals could convert balances from Coverdell Education Savings Accounts or Qualified Tuition Plans to LSAs, although the rules as proposed for doing so are complex. Likewise, other types of qualified tuition plans, such as those administered by state agencies, could be offered inside an LSA or continue to exist as separate types of accounts.

"This is the most controversial of the savings accounts because LSAs are extremely broad in scope – there are a variety of ways they can be funded and funds can be taken out at any time for any reason with all earnings being tax free," said Kaster. "Some see it as a way to encourage individuals to save more while others view it as favoring the wealthy."

The President's proposal would consolidate employer-sponsored 401(k), SIMPLE 401(k), 403(b), governmental 457, salary reduction SEPs (SARSEPs) and SIMPLE IRA plans into Employer Retirement Savings Accounts. Under the proposal, ERSAs would not replace nongovernmental 457 plans.

ERSAs would generally follow the existing 401(k) plan rules. However, there would be special rules for small employers, a single nondiscrimination requirement (rather than the complex ADP/ACP testing that currently governs employer and employee contributions to 401(k) plans) and a design-based safe harbor that could be used to satisfy the nondiscrimination test.

Accordingly, if the ERSA provisions became effective in 2006, employees could defer wages of up to $15,000 and employees age 50 or older would be able to take advantage of the catch-up contribution rules to defer an additional $5,000. The maximum total contributions to the plan would be the same as the existing defined contribution plan limit (the lesser of 100 percent of compensation or $42,000, assuming the limit was unchanged from 2005). Contributions could be made either in the form of pre-tax elective deferrals, after-tax employee contributions or Roth contributions depending on how the plan is designed.

After-tax Roth 401(k) plans are also scheduled to debut in the 2006 tax year and the President’s proposal would allow Roth ERSA contributions. Distributions of Roth and after-tax employee contributions would not be included in income. Qualified distributions of earnings on Roth ERSA contributions also would not be included in income. All other distributions would be included in the income of the participant.

Possibly anticipating criticisms that the proposals too heavily benefit the wealthy, the President’s proposals called for Individual Development Accounts (IDAs), explicitly targeted at lower-income individuals. IDA sponsors could be qualified financial institutions, nonprofit organizations or Indian tribes. Sponsors could gain tax credits for maintaining an IDA program. However, the accounts would have to be held by an institution currently eligible to serve as the custodian of IRAs.

The IDAs could be established by individuals between the ages of 18 and 60 who are not dependents or students. Single filers with incomes of $20,000; head of household filers with incomes at $30,000 or below or joint filers with incomes at $40,000 or below would be eligible. Sponsors would match contributions by eligible account holders on a dollar-for-dollar basis up to $500 per year.

Contributions to IDAs by individuals would not be deductible and the earnings on the contributions would be taxable to the account holder. However, matching contributions and earnings on those amounts would not be taxable to the account holder.

IDAs would allow qualified withdrawals of contributions and matching funds for higher education expenses, first-time home purchases and small business capitalization. However, the funds would not go directly to the participant. Rather, the financial institution at which the IDA is held would generally be required to disburse the funds to another financial institution (in the case of a home purchase or business start-up) or to an institution of higher education.

"While the Republicans have the majority in both the House and Senate, broad pension legislation, such as this proposed by the President, typically requires bipartisan support to pass. The two legislators spearheading pension legislation are Rep. Rob Portman (R-OH) and Rep. Ben Cardin (D-MD). If the President’s proposals get through Congress, it is likely that the vehicle would be a bipartisan bill co-sponsored by Portman and Cardin," said Kaster.

Kaster noted that a Portman-Cardin proposal appears to be in works and is likely to contain at least some of the President’s ideas, along with many other savings proposals.

CCH INCORPORATED (tax.cchgroup.com), based in Riverwoods, Ill., is a leading provider of tax and accounting information, software and services. CCH has served tax, accounting and business professionals and their clients since 1913, providing them with the most authoritative, timely and comprehensive tax resources. CCH is a Wolters Kluwer company (www.wolterskluwer.com).

Wolters Kluwer is a leading multinational publisher and information services company. The company’s core markets are spread across the health, tax, accounting, corporate, financial services, legal and regulatory, and education sectors. Wolters Kluwer has annual revenues (2003) of €3.4 billion, employs approximately 18,750 people worldwide and maintains operations across Europe, North America and Asia Pacific. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. Its depositary receipts of shares are quoted on the Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices.

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nb-05-16