RSAs will be subject to early withdrawal restrictions. Account holders must be at least 58 years old to make tax-free withdrawals. There will be no lifetime distribution requirements, and post-death distribution rules are expected to mirror the current Roth IRA Rules.
Employer Retirement Savings Accounts(ERSAs)
The current law provides for a number of similar tax-advantaged employer-sponsored retirement plans, each with their own rules and regulations. ERSAs would standardize and simplify these plans. Existing 401(k) and thrift plans would be renamed ERSAs and could continue to operate as before, subject to some simplification. Existing SIMPLE 401(k) plans, SIMPLE IRAs, SARSEPs, 403(b) plans and governmental 457 plans could be renamed ERSAs and be subject to ERSA rules, or could continue to be held separately. But if they are held separately, they could not accept any new contributions after December 31, 2004.
According to a U.S. Treasury press release, "ERSAs will follow the existing rules for 401(k) plans, but these rules will be greatly simplified. For example, the definition of compensation and the minimum coverage requirement will be simplified and the top-heavy rules will be repealed. Nondiscrimination requirements for ERSA contributions will be satisfied by a single test, and many firms may choose to adapt a new design-based safe harbor to avoid this test altogether." The proposal would not affect the rules applicable to defined benefit plans.
New Business Opportunities
IRA expert Ed Slott sees tremendous opportunities for financial planners if the President's proposals become law. "If all of this or even some of this makes it into law, then there will be all sorts of transition rules, grandfather rules and distribution rules to advise clients on. There will also be new estate planning opportunities to explore. Financial planners and estate planning attorneys will have more business than they can handle. Investment advisors, particularly those with wealthy clients, will benefit because over time, they will have more money to manage."
Robert S. Keebler, CPA, MST, of Virchow, Krause & Co. LLP, in Green Bay, Wis., sees a number of planning opportunities for wealthy individuals. "Assuming that the distribution rules for LSAs and RSAs are similar to the current Roth IRA regulations, many clients will want to place their RSAs and LSAs into a trust. A trust arrangement will offer two primary benefits: 1) Creditor protection and 2) The ability to include spendthrift provisions in the trust." He envisions parents and grandparents making use of the annual gift exclusion (currently $11,000 per person per donee), to fund LSA accounts and possibly RSA accounts for their children and grandchildren.
Keebler also sees the new accounts potentially "opening the floodgates for conversions from tax-deferred accounts, such as traditional IRAs, to the new savings vehicles."
"The window of opportunity for all account holders to convert and spread tax payments over four years is an added incentive," he says. "I'd need to see what the actual statutes say about re-characterization (undoing the conversion) before advising clients, but if the re-characterization rules were the same as the Roth IRA re-characterization rules, I don't see much downside in converting early because you retain the ability to re-characterize if necessary."
Probable Contributions Strategies
Individual clients will need help deciding where to deposit their retirement savings. As a general rule, clients eligible for any type of a match in their ERSA should first contribute at least enough to capture the full match. After that, assuming a constant tax bracket pre- and post-retirement, LSAs would appear to be the preferred savings vehicle because of their liberal contribution and withdrawal characteristics, as well as their tax-free status. Once a client's LSA is maxed out, they can contribute another $7,500 to an RSA; however, the decision would not always an obvious one. R. Saxon Birdsong, of Baltimore-Washington Financial Advisors Inc., says that on an after-tax contribution basis his analysis shows that clients would be better off contributing to the ERSA if they need to draw down the funds during retirement, but wealthy individuals who do not require the cash flow during retirement will be better off with the RSA. Clients who expect to be in a lower tax bracket post retirement will also be better off maximizing their contributions to ERSA plans before making contributions to RSAs.
Dubious Assumptions
Some commentators have suggested that the new accounts would greatly reduce annuity sales, but that is not necessarily true. While annuities will likely lose their allure as a tax deferral vehicle, the new accounts might actually increase their appeal as a source of cash flow during retirement that cannot be outlived. The guaranteed death benefit will still appeal to many.
There's also a question about the effect these new savings vehicles would have on small-business retirement plans. Some have suggested that there would be less incentive for small businesses to maintain existing qualified plans or to start new ones. Bruce J. Temkin, MSPA, EA, foresees a different scenario: "I spent over 80 hours analyzing the President's proposals, and I think qualified defined contribution plans will continue to appeal to many small businesses. The new bill would have a much more liberal safe harbor provision, so in many cases it will be easier for every employee, including the highest-paid employees, to maximize their plan contributions each year." Temkin suggests that most business owners will want to use a three-step process when analyzing their retirement savings options.