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NO MORE 401(k)S? IRA ACCOUNTS - GONE?

January 31, 2003

No, we are not talking about the market losses in our retirement accounts.

The administration this morning proposed a sweeping reform of the tax law's retirement savings incentives. Traditional IRAs, Roth IRAs, Simple IRAs, 401(k) contributions and 403(b) plans would join the Soviet Union and Arthur Andersen in history's dustbin. The new retirement planning world would be ruled by "Lifetime Savings Accounts," "Retirement Savings Accounts" and "Employer Retirement Savings Accounts."

These new accounts will be included in the President's budget proposal.

LIFETIME SAVINGS ACCOUNTS (LSAs) would accept individual contributions of up to $7,500 per year; this limit would be indexed for inflation. LSAs would have tax benefits similar to the current Roth IRA: contributions would be non-deductible, but earnings would not be taxable and withdrawals would be tax-free. Unlike Roth IRA amounts, LSA withdawals could be made at any time, with no minimum holding period.

No income or age limits would apply to LSAs. A newborn with no salary could make the same $7,500 annual contribution as Bill Gates. There would be no requirement to withdraw any amount after age 70½.

These accounts are expected to receive many contributions now deposited in Medical Savings Accounts (MSAs), Coverdell Education Savings Accounts (Education IRAs) and Section 529 plans. While these old plans will continue to be available, most taxpayers would probably fully fund the much less restrictive LSAs first. Existing MSAs, Coverdell accounts and Section 529 plans could be rolled into an LSA for a limited time.

RETIREMENT SAVINGS ACCOUNTS (RSAs) would replace traditional IRAs, non-deductible IRAs, and Roth IRAs. Individuals could make annual contributions of $7,500; this limit would be indexed for inflation. Like LSAs, RSA contributions would not be subject to any age or income limitations.

Roth IRAs would automatically become RSAs. Traditional IRAs and non-deductible IRAs would be eligible to convert their plans to RSAs for a limited time; such conversions would be taxable, except to the extent of non-deductible contributions. If not converted, traditional and non-deductible IRAs could remain in place, but would be unable to accept new contributions.

RSAs would look a lot like Roth IRAs. Contributions would be non-deductible, but earnings would accumulate tax free. RSA withdrawals would be tax-free after age 58, or upon death or disability.

EMPLOYER RETIREMENT SAVINGS ACCOUNT (ERSAs) would fill the ecological niches now occupied by 401(k) plans, 403(b) plans, governmental Section 457 plans, SARSEPS and SIMPLE IRAs. ERSAs would be employer-sponsored plans; any employer would be eligible to set one up.

The ERSA would look a lot like the current 401(k) plan. Employees could defer compensation to an ERSA on a pre-tax basis - in other words, ERSA contributions would reduce the income shown on the W-2. The annual contribution limit would be limited to the lesser of the employee's salary or $12,000 (increasing to $15,000 in 2006). The limit would be adjusted for inflation. These are the same limits that currently apply to 401(k) plans. As with 401(k) plans, taxpayers 50 years of age and up will be allowed "catch-up" contributions - $2,000 per year through 2005, and $5,000 annually afterwards.

Starting in 2004, all existing 401(k) plans would automatically become ERSAs. 403(b) plans, governmental Section 457 plans, SARSEPS and SIMPLE IRAs could remain in existence, but would be unable to accept new contributions; as a practical matter, most sponsors would probably convert such plans into ERSAs.

SIMPLIFIED DISCRIMINATION TESTING would replace current rules for ERSAs and all defined contribution plans. The highlights:

- There would be a single coverage test: the percentage of non-highly compensated employees covered by a plan would have to be at least 70% of the percentage of highly-compensated employees covered.

- "Permitted Disparity" and "Cross-Testing" will be prohibited.

-The "Top-heavy" rules would be repealed.

- A new uniform definition of "compensation" would be imposed: the amount of W-2 wages for withholding purposes, plus the amount of ERSA deferrals.

- The definition of "highly compensated" would be simplified; a highly compensated employee would simply be anyone whose compensation for the previous year exceeded the FICA wage base.

WHEN WOULD THIS TAKE EFFECT? The proposals are to take effect beginning in 2003. Of course, all of this is subject to the whims of Congress, so there is no telling what, if anything, will result from this proposal.

IS IT A GOOD THING? For most folks, it looks like a good thing. The elimination of income limits, eligibility phase-outs and multiple IRA versions can only be good policy. The devil's in the details, though, and these will emerge in the coming days. Stay tuned.

Roth & Company's legal staff is examining whether the LSA violates our "naming rights" deal for the Roth IRA.

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