The President's Savings Plans
The President's Savings Plans
By: Norbert J. Michel
Date: March 29, 2005
Source: Heritage Foundation. "The President's Savings Plans: Good for Retirees … and Everyone Else." 2005 <http://www.heritage.org/Research/Taxes/wm704.cf m> (accessed June 22, 2006).
About the Author: Norbert Michel is a Policy Analyst in the Center for Data Analysis at The Heritage Foundation, a Washington-based public policy research institute.
The concept of retirement, a final phase of life in which seniors leave the workforce to enjoy their accumulated assets, is a relatively modern phenomenon. For much of human history men and women have assumed that work was a necessary part of life, and that those able to work should do so. The idea of quitting work simply to enjoy life while others paid the bills appeared somewhat suspect, possibly implying some form of laziness or lack of morals.
Mortality and retirement statistics give some insight into the recent history of the retirement mind-set. In 1930 the average American lived to about age sixty. Despite the fact that many men never reached the current retirement age of sixty-five, among those who did the labor force participation rate (the percentage still working) was surprisingly high: 58 percent. For those who reached old age in the 1930s, work often continued much as before.
With the passage of the Social Security Act of 1935, a financially secure retirement became possible for many more Americans. This guaranteed source of retirement income, coupled with improved healthcare and longer life spans, enabled a growing number of workers to retire and enjoy their "golden years" at home or traveling. By 1970, workforce participation rates for sixty-five-year olds had fallen by almost half to 35.2 percent, and by 2000 fewer than 18 percent of sixty-five-year olds remained in the workforce; as of 2003 approximately one in six Americans was receiving some form of Social Security benefits and the system was paying out almost half a trillion dollars annually.
While the trend toward longer retirement creates more post-work years for Americans to enjoy, it also means that retired workers will receive Social Security benefits for much longer than before. Whereas a typical worker in 1940 might have drawn payments for five years or less, a typical retiree in 2000 will claim benefits for twenty years or more, despite having worked roughly the same length of time. In addition, a 1972 law indexed Social Security payments to inflation, meaning that the dollar value of payments rises automatically each year. This change helps protect retirees from inflation and maintain their buying power, but also increases the financial strain on the system by raising expenditures each year.
By the 1970s, the Social Security System was beginning to show cracks and in 1983 Congress enacted changes to help shore up the program. These changes included raising withholding rates and taxing benefits for some higher income retirees, and were expected to stabilize the system until 2040 or 2050. But within a few years, new projections once again showed the system exhausting its funds earlier than planned. Soon the fate of Social Security became a recurring political topic.
Social Security's problems have spawned numerous suggestions; sure fixes such as cutting benefits or raising the retirement age substantially have been deemed political suicide by most politicians and discarded. However with the Baby Boom generation nearing retirement, the system's structure is mathematically top-heavy: As the number of retirees grows the number of workers supporting them will shrink. Projections in 2006 see the system unable to pay full benefits by approximately 2040.
Beside the attention being paid to Social Security itself, the federal government is also implementing programs that encourage Americans to save more on their own. Individual Retirement Accounts (IRAs), written into law in the 1970s, were one of the first such programs created. In 2004 President Bush proposed two new savings programs that would provide tax breaks to Americans saving for retirement.
THE PRESIDENT'S SAVINGS PLANS: GOOD FOR RETIREES … AND EVERYONE ELSE
Previous attempts to solve Social Security's problems have relied on a mix of benefit cuts and tax increases, but this approach is not a long-term solution. A more lasting solution to Social Security's problems involves a two-pronged approach that allows workers to invest part of their payroll taxes in their own accounts while also removing barriers to saving outside of the system. Although legislation has not yet been introduced to address the first part of this strategy, bills dealing with the second portion have been introduced in both chambers of Congress.
On March 8, Treasury Secretary John Snow, Senator Craig Thomas (R-WY), and Representative Sam Johnson (R-TX) announced the Save Initiative, a legislative effort that includes three new savings proposals. These savings plans were part of President Bush's 2006 budget proposals and are likely to be included in any tax reform package developed later in the year. The bills would encourage people to save money and would greatly simplify the regulations governing retirement accounts.
Increase Saving, Reduce Complexity
By eliminating multiple layers of taxation, the Save Initiative 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 as well as the money earned in those accounts, the new plans would ensure that savings are taxed only once. Just as important, the Save Initiative would consolidate the various types of tax-advantaged savings accounts and simplify their regulations. The proposed savings plans include:
Lifetime Savings Accounts.
LSAs 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), but the earnings on the money will not be taxed. Unlike typical retirement accounts, there will be no "early withdrawal" penalty, ensuring that savings can be used for whatever purpose individuals choose and that they are taxed only once.
Retirement Savings Accounts.
The RSA is similar to the Roth IRA in that money goes into the account after taxes (up to $5,000) and the account is not taxed again. Investors are allowed to accumulate earnings in the RSA tax-free and then to use the money at retirement without paying additional taxes. Unlike the Roth IRA, there are no income limits preventing people with higher incomes from contributing. Like the Roth IRA, there are no additional age requirements mandating withdrawals after retirement.
Employer Retirement Savings Accounts.
ERSAs would consolidate the plethora of employer-based saving plans, such as 401(k), Simple 401(k), and 403(b) plans, and simplify the qualifying rules. The ERSA rules would be similar to the current-law 401(k) rules, and contributions would be pre-tax. Existing plans could be maintained in their previous form, but new contributions would be disallowed after December 31, 2006.
Help Retirees … and Everyone Else
Allowing individuals to build their own wealth is an integral part of a market economy, and removing excess layers of taxation on saving can only help to increase private wealth. The Save Initiative would be a boon both to younger workers who currently hold out little hope of receiving their future Social Security benefits and to baby boomers who are on the verge of retiring.
Economists believe that Social Security provides a disincentive to save. As noted in the Economic Report of the President, the current multitude of special-purpose tax advantage accounts encourages people to create several smaller pools of saving that can be used only for specific purposes. There is also evidence that taxing consumption rather than income would be more efficient and would boost economic activity. The Save Initiative would help in all three cases.
The new proposals remove a layer of taxation on saving, thus providing a greater incentive to save for any reason, including retirement. Furthermore, the new savings plans move the income tax system toward a consumption tax because not taxing savings is the equivalent of taxing only consumption. For all individuals, whether young or old, rich or poor, the Save Initiative translates into easier saving through lower costs and less complexity.
Minimal Impact on the Federal Budget
Advocates of tax reform can also take comfort from the fact that the Save Initiative would have a minuscule impact on the federal budget. According to the Joint Committee on Taxation, consolidating the plethora of retirement accounts and creating the new LSA plans would reduce federal revenue by $5.4 billion between 2005 and 2015. This figure represents less than one-fifth of 1 percent of the $3 trillion federal budget.
Allowing individuals to build their own wealth is an integral part of a market economy, and the policies embodied in the Save Initiative can only help to increase private wealth. The Save Initiative should be part of any tax reform package because it provides the proper incentives for individuals to save and reduces complexity in the tax code. These savings plans could also be an important first step toward meaningful Social Security reform because they would encourage people to save for their own retirement. Congress should consider going even further than the current proposals and removing all contribution limits from the new savings plans.
Although many members of Congress recognize the need to improve Americans' retirement security, they are divided on how to accomplish this goal. President Bush's proposal attempted to raise non-Social Security savings by offering tax incentives which would allow earners to invest in tax-sheltered savings accounts. Critics of the plan charged that the proposed changes would favor the wealthy, who have income to save, while reducing pressure to shore up Social Security. In place of the president's plan, opponents generally favor higher withholding on wealthy taxpayers.
Despite its popularity with some supporters, the president's savings proposals did not survive the budget process and were eliminated before the final 2004 budget was approved. Similar proposals came from the White House for the 2005 and 2006 budgets, but were again rejected. The proposal was once again recommended for the 2007 federal budget.
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