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Savings accounts could be tax-free

Updated: May 3, 2013 12:14PM

Originally published: February 2, 2003

When President Bush presents his budget to Congress this week, it will include two bold new savings proposals that will allow all Americans, regardless of age or income, to save money in tax-free accounts.

The Lifetime Savings Account (LSA) would allow anyone to open a savings or investment account and put away an after-tax amount up to $7,500 a year. The money would grow tax-free and could be withdrawn without penalty at any time and used for any purpose.

The proposed Retirement Savings Account (RSA) would operate like the current Roth IRA. Up to $7,500 a year in after-tax income could be contributed to this RSA. Money growing in these accounts would be distributed tax-free after age 58, or in the case of death or disability.

These new accounts would do away with complex rules that affect current savings plans such as traditional IRAs, Medical Savings Accounts and Coverdell Education Accounts. In fact, many of these traditional plans might be converted to the two new plans.

These two simple accounts--an individual could contribute to each of them in the same year--could encourage more savings by eliminating complicated rules. Since money could be withdrawn from the LSA for any purpose, savers would no longer have to deal with penalties, taxes and explanations of how the money would be used.

Critics contend the new Bush plan would do nothing for poor and middle-income people because their savings levels are, as it is, well below the existing contribution limits for IRAs.

“This is oriented to high-income people,” said Dean Baker, an economist with the Center for Economic and Policy Research, a liberal think tank. “This allows people to put more money into tax-sheltered accounts, but the vast majority of the population doesn’t have enough money to contribute to these accounts under the old limits.”

Supporters of the plan, however, suggest that the reason low-income people don’t save more is that they are intimidated by the maze of rules and lack of liquidity for existing plans.

“No longer will people have to worry about the endless maze of confusing rules,” said Pam Olson, Treasury’s assistant secretary for tax policy. “The two simple accounts will have one powerful goal--making saving for everyday life and retirement security easier and more attractive.”

Banks, brokerage firms and mutual fund companies could do away with all sorts of forms and documents that now perplex and discourage would-be savers. After-tax contributions need not be documented on an individual tax return. And withdrawals from the LSA would not be reported, either. There would be no required distributions from the RSA in later life, as is the case with most current retirement plans.

It is anticipated that the $7,500 annual contribution limit to each of these individual plans would be indexed to inflation.

Additionally, employer retirement plans, which now include 401(k), 402(b), SIMPLE 401(k) plans, SARSEPS, government 457 plans and SIMPLE IRAs, would all be replaced by a new Employer Retirement Savings Account, which would be similar to the current 401(k) plan, but with a more simplified set of rules. Initial contributions to these pre-tax employer plans would have a limit of $12,000 initially, rising to $15,000 by 2006.

Although many people could not afford to make the maximum contribution, even a small addition to savings each year could build up a sizable reserve for emergencies, or a substantial retirement account over time.

As an example, if today’s 20-year-old were able to set aside $7,500 a year, every year, for the next 50 years, in a stock market index fund that grew annually at the 75-year historic average of 10.6 percent, those contributions would grow to nearly $12 million in today’s dollars. Even starting smaller, at just $2,000 a year--or about $40 a week--the account could grow to more than $3 million, based on historic averages.

The plan is just a proposal, of course, and is part of the president’s budget message. But since it benefits low-income people, as well as the wealthy, it is likely to appeal to both sides of the political aisle.

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