Simplifying Savings

Commentary by Pete du Pont

Passbook savings accounts went the way of rotary-dial telephones when the banking industry was deregulated in the 1970s so that the Federal Reserve Board no longer set the interest rate banks could pay. In the years since, Congress has created a variety of accounts to encourage saving in general and for specific purposes - including retirement, education, health care and house down payments.

President Bush has proposed consolidating and simplifying some of these accounts to make it easy for any employer to create a retirement savings plan and for all workers to establish savings accounts.

A major reason for the attractiveness of the various savings plans and accounts available today is the tax treatment of income saved and the interest earned. Some accounts allow workers to save pretax dollars - lowering their taxable incomes today and thus deferring taxes on both the contributions and reinvested interest or dividends until the funds are withdrawn. Others require deposits from after-tax dollars, but do not tax the contributions or accumulated interest when the money is withdrawn.

These tax-advantaged accounts have become popular, particularly for retirement savings. According to the Joint Economic Committee of Congress, savings in Individual Retirement Accounts (IRAs) and defined-contribution retirement plans such as 401(k)s have grown from $1.4 trillion in 1990 to an estimated $4.9 trillion in 2001.

A major drawback of some existing types of accounts is that to get the tax advantage, there are restrictions on who, how, when and what: who can contribute, how much they can contribute or earn, when they can withdraw funds and what they can do with the money withdrawn. Unless the account-owner navigates the system correctly, he or she can end up owing not only taxes, but penalties. These complications, and the possibility of not being able to access needed savings for legitimate needs, discourages many low income workers from saving at all.

President Bush has proposed replacing some of these accounts with three new basic types of accounts.

Employer Retirement Savings Accounts (ERSAs) would allow workers to contribute from their wages before taxes and defer tax payments until retirement, when most taxpayers will face the same or a lower tax rate. They would replace 401(k), SIMPLE 401(k), 403(b) and 457 employer-based defined contribution accounts with a single type of plan that could be more easily established by any employer.

Assistant Secretary of the Treasury Barbara Olson notes, "The overwhelming complexity of current rules imposes substantial burdens on employers and workers....It's one important reason why only 50 percent of working Americans have any pension plan at all." Less than 25 percent of employees of small firms have any employer-sponsored retirement plan.

Retirement Savings Accounts (RSAs) would allow everyone to contribute - with no limitations based on age or income - with after-tax contributions that would grow tax free and could be withdrawn tax free. Up to $7,500 could be contributed to an RSA. Like Roth IRAs under current law, contributions would not be deductible but earnings would accumulate tax free and distributions after age 58 (or death or disability) would be tax free.

Lifetime Savings Accounts (LSAs) could be used for any type of saving. Any individual, regardless of age or income, would be able to contribute $7,500 a year and make penalty free withdrawals at any time for any reason. Contributions would not be deductible but earnings and distributions would be tax free.

For a beginning saver, an LSA could initially be a savings account earning simple interest. As the account grows, workers could move some of the funds to higher-paying bond funds or equity investments Taxpayers would not be required to document qualified expenses, financial institutions would not need to explain complicated rules to participants, and the government would not need to verify that withdrawals were "qualified."

The president's plan has been criticized on the grounds that (what else?) it is a tax break for the "rich" because some income limits on contributors are eliminated and contribution amounts are raised; and that it won't increase savings because the "rich" will simply shift their tax-sheltered investments to these accounts.

But the critics miss the point: the aim of this plan is to encourage all workers - young and old, low income and middle income - to save. Simpler, more accessible savings accounts and plans would go a long way toward that goal.