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February 10, 2003
Bush Administration
Proposes New
Tax-Favored Savings Programs
The
Bush Administration recently proposed dramatic changes in the rules
for tax-favored savings programs:
- Create new Employer
Retirement Savings Accounts (ERSA) to replace various employment-based
defined contribution plans that allow individual employees to save
on a pre-tax or post-tax basis (e.g., Section 401(k) plans,
§403(b) plans and §457 plans) and
- Create two new
types of tax-advantaged individual savings vehicles: Lifetime Savings
Accounts (LSAs) and Retirement Savings Accounts (RSAs). RSAs would
replace the various types of IRAs now available. LSAs would be an
alternative to the current array of categorical non-retirement savings
vehicles (e.g., medical and education savings accounts).
This Compliance
Alert summarizes what is known about the features of the proposals
that are most likely to be of interest to employers and plan sponsors.
Because the proposals are in the conceptual stage, few operational details
are available.
To see the Treasury
Department's press release announcing the proposals, which includes
questions and answers about the proposals, click here.
ERSAs
The proposal to
create ERSAs includes the following features:
- Tax Treatment
of Contributions The tax treatment would be the same as under
current law: employees' pretax deferrals would not be taxed at the
time they are made, but withdrawals would be taxed at then-applicable
income tax rates.
- Contribution
Limits Employees' pretax contributions to ERSAs would be allowed
up to the current dollar limits for §401(k) and similar plans (i.e.,
$12,000 for 2003, rising to $15,000 in 2006, plus catch-up contributions
for those age 50 and over). Employees of educational and charitable
organizations would no longer be able to save the maximum through
each of two separate retirement vehicles.
- Nondiscrimination
Testing The special §401(k)/(m) nondiscrimination tests would
be simplified as follows:
- If non-highly
compensated employees contribute, on average, more than 6 percent
of pay, there would be no limit on contributions by highly compensated
employees. If the average for non-highly compensated employees
is 6 percent or less, the average for highly compensated employees
could be no more than two times that rate.
- Public-sector
ERSAs would be exempt from these tests, and
- ERSAs maintained
by private-sector charitable organizations would be exempt from
these tests, but all employees earning at least $200 per year
would have to be given the chance to contribute.
The current design-based
safe harbors would remain available.
In addition, the
Bush Administration has proposed simplifying the nondiscrimination rules
for all private sector defined contribution plans, including those that
do not provide for individual employee contributions. (No changes would
be made in the rules for defined benefit plans.) Proposed changes to
the nondiscrimination rules for private sector defined contribution
plans, include the following:
- A plan could
only satisfy minimum coverage by meeting the 70 percent test, which
requires that the percentage of non-highly compensated employees covered
be at least 70 percent of the percentage of highly compensated employees
who are covered.
- Permitted disparity
(i.e., higher employer contributions on pay above the Social
Security wage base) would not be allowed, and defined contribution
plans could no longer use a defined-benefit format (cross-testing)
to prove that they are not discriminatory.
- The top-heavy rules would be repealed.
- The term "highly compensated employee" would be defined as an employee
who, in the previous year, made more than that year's Social Security
wage base, and
- "Compensation" would be defined as W-2 pay plus specified salary-reduction
amounts.
LSAs and RSAs
The two types of
individual savings vehicles that the Bush Administration has proposed
would be similar to one another in many regards:
- Tax Treatment of Contributions Contributions to these
accounts would not be tax deductible, but the earnings would be tax-exempt
when withdrawn (like Roth IRAs, under current law).
- Contribution Limits The maximum annual contribution
to an individual's LSA would be $7,500, and that would also be the
maximum annual amount that could go into his or her RSA, so each person
could have total tax-sheltered individual savings of $15,000 in the
first year (these limits would be indexed).
Anyone who has the money could contribute both to an LSA and to
an RSA, without regard to income level or participation in an employment-based
plan, not only for herself but also for anyone else she chooses,
up to the annual dollar limit for each person's account.
There would be a
few differences between LSAs and RSAs, as follows:
- Funds could be
withdrawn tax free from an LSA at any time and for any reason. Tax-free
withdrawals from RSAs would only be allowed once the account holder
reaches age 58, dies or becomes disabled.
- Contributions
to LSAs apparently could be made from any source. Contributions to
RSAs could not exceed the individual's compensation for the year.
Outlook
The proposals, as initially outlined, have been sharply criticized
by private-sector benefits groups. It is too early to say whether they
might become law, with or without modification. The Segal Company will
monitor the progress of these and other benefits reform proposals and
will keep clients informed about any significant legislative developments.
| Compliance Alert, The Segal Company’s
periodic electronic newsletter summarizing important developments
affecting benefit plan compliance, is for informational purposes
only. It is not intended to provide authoritative guidance. On all
issues involving the interpretation or application of laws and regulations,
plan sponsors should rely on their attorneys for legal advice. |
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