[17042]
February 4, 2004
TO: 529 PLAN ADVISORY COMMITTEE No. 4-04
OPERATIONS MEMBERS No. 7-04
PENSION MEMBERS No. 7-04
PENSION OPERATIONS ADVISORY COMMITTEE No. 9-04
TAX MEMBERS No. 7-04
TRANSFER AGENT ADVISORY COMMITTEE No. 15-04
RE: PRESIDENT’S 2005 BUDGET INCLUDES SAVINGS AND RETIREMENT INITIATIVES
The President’s Budget for fiscal year 2005 includes several savings and retirement
initiatives, including Retirement Savings Accounts (“RSAs”), Lifetime Savings Accounts
(“LSAs”), Employer Retirement Savings Accounts (“ERSAs”) and Individual Development
Accounts (“IDAs”). These proposals are similar in many respects to proposals included in the
President’s budget for fiscal year 2004.1 One of the biggest changes from last year’s proposals is
a reduction in the contribution limits for RSAs and LSAs from $7,500 to $5,000. This year’s
proposal also adds the IDA, a savings vehicle with a tax-credit matching feature intended to
encourage savings among lower income individuals.
A. RSAs
The President’s RSA proposal is essentially the same as last year’s proposal, except that
last year’s contribution limit of $7,500 is reduced to $5,000 (indexed for inflation). This account
would not impose age or income limitations, except that contributions cannot exceed
compensation. Like Roth IRAs, contributions to RSAs would be nondeductible, account
earnings would accumulate tax-free and qualified distributions would be excluded from gross
income. The President’s proposals regarding RSAs would become effective beginning on
January 1, 2005.
1 See Institute Memorandum to 529 Plan Advisory Committee No. 7-03, Operations Members No. 4-03, Pension
Members No. 7-03, Tax Members No. 7-03 and Transfer Agent Advisory Committee No. 13-03 (15601), dated January
31, 2003. Attached are relevant excerpts from the President’s FY 2005 budget. The Treasury Department’s press
release at http://www.treas.gov/press/releases/js1131.htm provides additional information regarding these
proposals.
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1. Special Rules for RSAs
Qualified distributions from RSAs could be made after age 58 or in the event of death or
disability. Nonqualified distributions in excess of prior contributions would be included in
income and subject to additional tax. Married individuals could roll amounts from their RSAs
to their spouse’s RSAs. Additionally, the saver’s credit would apply to RSA contributions.
2. Conversions to RSAs
The President’s proposal would rename Roth IRAs to RSAs and subject them to the new
RSA rules. Existing traditional and nondeductible IRAs could be converted to RSAs in a
manner similar to current Roth IRA conversions - by taking the conversion amount into gross
income. Conversions would not be subject to income limitations and would not be mandatory.
Taxpayers who convert their IRAs to RSAs prior to January 1, 2006 could include the conversion
amount in income ratably over four years. Conversions made on or after January 1, 2006 would
be included in income in the year of conversion. Existing traditional and nondeductible IRAs
that are not converted to RSAs could not accept any new contributions after 2004.
New traditional IRAs also could be created to accept rollover contributions from
employer plans, but these accounts could not accept any new contributions. Additionally,
individuals could roll over amounts from an employer plan directly into an RSA by first taking
the rollover amount into income. Amounts converted to an RSA from a traditional IRA or from
an ERSA would be subject to a five-year holding period starting with the year of the conversion.
Distributions attributable to either a traditional IRA or ERSA and made prior to the end of the
five-year holding period would be subject to an additional 10 percent early distribution tax on
the entire amount of the distribution.
B. LSAs
The President’s LSA proposal is essentially the same as last year’s proposal, except that
last year’s contribution limit of $7,500 is reduced to $5,000 (indexed for inflation). This account
would not impose age or income limitations. Like Roth IRAs, contributions to LSAs would be
nondeductible, account earnings would accumulate tax-free and qualified distributions would
be excluded from gross income. The President’s proposals regarding LSAs would become
effective beginning on January 1, 2005.
1. Special Rules for LSAs
With respect to LSAs, no minimum required distribution rules would apply to the
account owner at any time. The $5,000 contribution limit applies to the individual account
owner and not the contributor. Thus, contributors could make annual contributions to the
accounts of other individuals, provided, however, that annual aggregate contributions to an
individual’s account do not exceed $5,000. Control over an account in a minor’s name would be
exercised exclusively for the minor’s benefit by the minor’s parent or legal guardian until the
minor reached the age of majority (as determined by state law). Married individuals could roll
amounts from their LSAs to their spouse’s LSAs.
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2. Conversions to LSAs
The President’s proposal permits conversion of balances in Coverdell Education Savings
Accounts (“ESAs”) or 529 Plans into LSAs. All conversions must be made before January 1,
2006, subject to certain limitations. The amount that may be rolled over to an LSA from a 529
Plan is limited to the sum of (1) the lesser of $50,000 or the amount in the 529 Plan as of
December 31, 2003 and (2) any contributions and earnings to the 529 plan in 2004. Total
rollovers to an individual’s LSA attributable to 2004 ESA and 529 Plan contributions, however,
cannot exceed $5,000 plus earnings on those contributions.
Individuals could also choose to continue to contribute to ESAs and 529 Plans as under
current law, and these education accounts could be offered inside an LSA. For example, states
could offer LSAs with the same investment options available under the state’s 529 plan. Such
an LSA would not be subject to the 529 Plan’s reporting requirements, but investors would be
subject to the annual LSA contribution limit. Distributions for purposes other than education
would not be subject to federal income tax or penalties. States could, however, offer state tax
and other incentives for using such LSA funds exclusively for education. Health Savings
Accounts (“HSAs”) and Archer Medical Savings Accounts (“MSAs”) would also be retained as
under current law.
C. ERSAs
The President’s ERSA proposal would consolidate 401(k) plans, SIMPLE 401(k) plans,
403(b) plans, governmental 457 plans, SARSEPS and SIMPLE IRAs into one retirement plan. 2
The ERSA would be available to all employers and would be subject to simplified
administrative rules that generally follow the rules applicable to 401(k) plans. Employees could
defer wages of up to $13,000 annually (increasing to $15,000 by 2006), with employees aged 50
and older able to defer an additional $3,000 per year (increasing to $5,000 by 2006).
The maximum total contribution (including employer contributions) to ERSAs would be
the lesser of 100 percent of compensation or $41,000. ERSA contributions could include pre-tax
deferrals, after-tax employee contributions or Roth-type contributions, depending on the design
of the plan. Distributions of Roth-type and non-Roth after-tax employee contributions would
be excluded from income. All other distributions would be included in income. This proposal
would become effective for years beginning after December 31, 2004.
1. ERSA Discrimination Testing
A single nondiscrimination test would apply to ERSA contributions: the average
contribution percentage (the sum of all employee and employer contributions divided by the
employee’s compensation) of highly compensated employees (“HCEs”) could not exceed 200%
of non-highly compensated employees’ (“NHCEs”) percentage if the NHCEs’ average
contribution percentage is six percent or less. No discrimination testing is applied if the average
contribution percentage of NHCEs exceeds six percent. Additionally, employers could avoid
2 Rules applicable to defined benefit plans would not be affected by the ERSA proposal.
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discrimination testing by implementing a design-based safe harbor such that all eligible NHCEs
receive fully vested employer contributions equal to at least three percent of compensation.
ERSAs sponsored by state and local governments would not be subject to
nondiscrimination testing at all under certain circumstances. Employers with 10 or fewer
employees making $5,000 could choose to offer a custodial ERSA, which would be exempt from
annual reporting requirements and most ERISA fiduciary rules, similar to the relief currently
provided to the SIMPLE IRA. The employer’s contributions to the custodial plan must satisfy
the three-percent design-based safe harbor described above.
2. ERSA Conversions
Existing 401(k) and thrift plans would be renamed ERSAs and could continue to operate
as under current law, subject to the simplified ERSA rules. Existing SIMPLE 401(k) plans,
SIMPLE IRAs, SARSEPs, 403(b) plans and governmental 457 plans could be renamed ERSAs
and become subject to the ERSA rules; or these plans could continue to exist separately but
could not accept new contributions after December 31, 2005. Special transition rules would
apply to collectively bargained plans and plans sponsored by state and local governments.
D. IDAs
The President’s budget for fiscal year 2005 expands the attractiveness of IDAs, a savings
vehicle designed to encourage savings among lower income individuals. IDAs are accounts
that would provide dollar-for-dollar matching contributions up to $500 for single filers with
incomes below $20,000, joint filers with incomes below $40,000 and head of household filers
with incomes below $30,000. Individuals between the ages of 18 and 60 who are not
dependents or students would be eligible to establish an IDA. Matching contributions would
be supported by a 100% tax credit given to sponsoring financial institutions that provide
savings matches to account holders. The proposal also includes a $50 per account credit for
financial institutions to cover the costs of maintaining, administering and providing financial
education with respect to IDAs.
Contributions to IDAs would be non-deductible and earnings would be taxable to the
account holder. Qualified withdrawals of contributions and matching funds would be
permitted for higher education, first-time home purchases and business capitalization.
Nonqualified withdrawals of matching funds are not permitted and nonqualified withdrawals
of participant contributions could result in forfeiture of matched funds. The credit would apply
with respect to the first 900,000 IDA accounts opened before January 1, 2010 and with respect to
matching funds made after December 31, 2004 and before January 1, 2012. The credit could
generally be claimed for taxable years ending after December 31, 2004 and beginning before
January 1, 2012.
Lisa Robinson
Assistant Counsel
Attachment
Note: Not all recipients receive the attachment. To obtain a copy of the attachment, please visit our members website
(http://members.ici.org) and search for memo 17042, or call the ICI Library at (202) 326-8304 and request the
attachment for memo 17042.
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Attachment (in .pdf format)