February 8, 2004

February 8, 2004 | WebMemo on Social Security

The Forgotten Savings Plans

The ink isn't even dry on the President's new budget, and many in Congress, for all sorts of reasons, are already attacking it. In a fashion very similar to what happened last year, it seems that arguments over the budget deficit will relegate the President's proposed savings plans to being nothing more than an idea. If so, this will mark the second year in a row that one of the President's best ideas remains largely unnoticed.

Three Plans

By allowing individuals to save their money without multiple layers of taxation, the proposed plans would give taxpayers added incentives to save money and build their own wealth. Unlike current law, which taxes the money put into regular savings accounts and the money earned in those accounts, the new plans would ensure savings are taxed only once. Collectively, the proposal would consolidate the various types of tax-advantaged savings accounts and simplify their regulation.

Here is a summary of the proposed savings plans:

  • Lifetime Savings Account (LSA). These accounts can be used to save for any purpose, not just retirement. There is no tax advantage on the money going into the account (up to $5,000 annually), but earnings are not taxed. Unlike with typical retirement accounts, there is no "early withdrawal" penalty, ensuring that savings can be used for whatever purpose individuals choose and that they are taxed only once.
  • Retirement Savings Account (RSA). The RSA is similar to the "Roth IRA" in that money goes into the account after taxes (up to $5,000 annually) and the account is not taxed again. Investors are allowed to accumulate earnings tax-free in the RSA and can use the money at retirement without having to pay additional taxes. Unlike the Roth IRA, there are no income limits preventing people with higher incomes from contributing.
  • Employer Retirement Savings Accounts (ERSA). These accounts consolidate the plethora of employer-based saving plans (the 401(k), Simple 401(k), 403(b), etc.) and simplify their qualifying rules. The ERSA rules are similar to the current-law 401(k) rules, and the tax-advantage feature is the same as the plan it replaces. For instance, if after-tax funds are contributed to an employer plan (Roth IRA-style contributions), then contributions to the ERSA are also after-tax.

These savings plans are indicative of why America is viewed as the land of opportunity. One of the great promises of America is that its citizens are free to create their own wealth. Taxation of that wealth at every possible opportunity only serves to lessen individuals' incentives to save and to divert their efforts. Rather than spending time on productive wealth-creating endeavors, which would help provide opportunities for others, individuals now devote too many resources to keeping wealth out of the government's reach.

The idea behind creating these accounts is sound. Providing individuals with better incentives to build their own wealth is exactly why the free market has proven superior to "planned" economies. It is precisely because LSAs, as well as the simplifying RSA and ERSA plans, would provide good incentives for individuals that they should be put before Congress.

About the Author

Norbert J. Michel, Ph.D. Research Fellow in Financial Regulations
Thomas A. Roe Institute for Economic Policy Studies