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Lifetime Savings Accounts

One of the items on President Bush's tax agenda deserves more widespread discussion, and prompt action from Congress to enact. Politically, it ought to be a much easier fight than Social Security reform, making his tax cuts permanent, or an overhaul of the whole tax system. I'm talking about Lifetime Savings Accounts.

The idea has been languishing in the sidelines for several years and has undergone a few modifications during that time. This press release from early 2004 has a good description of LSA features:

  • $5,000 annual contribution limit (indexed for inflation).
  • Available to all individuals — no income limits, no age limits.
  • Contributions would be nondeductible (like Roth IRAs).
  • Earnings would accumulate tax-free and all distributions would be excluded from gross income.
  • No minimum required distribution rules would apply at any age throughout owner's life.
  • Contribution limit of $5,000 applies to the individual owner of the account, not the contributor.
  • Contributors could make annual contributions to the accounts of other individuals.
  • Annual aggregate contributions to an individual's accounts could not exceed $5,000.

The key bullet is the fourth one. Read it literally. All distributions are excluded from gross income. There are no penalties of any kind. These accounts can be used for any purpose, not just for retirement savings.

This amounts to a repeal of all savings and investment taxes for the majority of American households. This is something to celebrate, get enacted into law, and celebrate again. (Household median income is around $43,500, so if a household has two people, it could save $10,000 annually in LSAs — over 20% of its total income; much more than is realistic.)

This tax cut removes a disincentive to save. It's important and noteworthy that with LSAs, the government is not playing nanny by telling you how or when to spend your savings. It's up to you. You get to spend it on your own priorities, not someone else's. This is what the "ownership society" should really be about: Individual empowerment through ownership.

The fact that anyone can contribute to anyone else's LSA is a powerful feature. For example, an LSA could be established for a child's college education fund. Many relatives and friends could all contribute to it.

I can already anticipate the backlash: "People might spend their LSAs on stupid things like fancy cars or big televisions!" Yes, they might. And it's their right to do so. It's their money. The solution to financial stupidity is advice and education, not forcibly limited options. (For this reason I would prefer to see Roth IRAs eliminated and LSA contribution limits correspondingly increased.)

Bush's proposal would also rename and improve Roth IRAs. They would now be known as Retirement Savings Accounts (RSAs), would have a $5,000 contribution limit, and would not be phased out for high-income people.

Continuing in the spirit of renaming and consolidation, Employer Retirement Savings Accounts (ERSAs) would replace 401(k) and similar plans. The rules are 401(k)-like, and include the option of Roth-like contributions as I wrote about previously. The contribution limit would be $15,000.

A dedicated saver could use all three — LSA, RSA and ERSA — to save $25,000 annually and never pay any taxes on any of the earnings. (And, all the contribution limits are inflation-indexed.) This is such a huge quantity of money that only people with very high incomes would still be subject to any investment taxes.

On purely economic grounds, I prefer tax cuts for the wealthy over tax cuts for the poor … and I suppose I should write about why, next … but LSAs are still a great idea. Besides, in the long run they might pave the way for a total elimination of all investment taxes. Camel's nose and all that.

I love this plan! I'm excited to be a part of it! Let's do it!

(You may wonder why I didn't mention Bush's other proposal, Individual Development Accounts. I haven't made up my mind yet on these.)

Tiny Island