Supersize that IRA

CSE Note: Treasury Assistant Secretary for Tax Policy Pamela Olsen gave a speech on Monday, June 2, that put non-taxable retirement accounts back on the agenda. She proposed Lifetime Savings Accounts (LSAs), which would combine many of the existing savings plans and give taxpayers more control over their own money. According to Olsen, these tax-free savings accounts could “fund a college education, start a business, buy a first home, save for emergencies, or used for retirement.” Taxpayers can put up to $7,500 a year into these accounts, with no restrictions on age or income. She also spoke of the need to create Employer Retirement Savings Accounts (ERSAs) which would consolidate the six existing types of plans into one. The complexity of the tax code has discouraged people from creating individual retirement accounts. In 1982, the IRS publication for individual accounts was only 12 pages long—today it is 104 pages. This complexity also reveals the lack of trust some in the government have of the ability of taxpayers to spend their own money. Low-income families especially need the ability to withdraw money from their savings accounts in the case of an emergency. 104 pages of government regulation can stop them from doing this, discouraging savings.

The introduction of LSAs and ERSAs to the agenda is a big step forward in the struggle for the right of taxpayers to spend their money how they think is best.

Excerpts from Speech by Pamela Olsen, Treasury Assistant Secretary for Tax Policy

“…

While the Jobs and Growth Act has better aligned our tax rules with our economic interests and our values, there are still ways in which our tax rules are inconsistent with the core values of American society. One of those is of special concern to those of you associated with today’s Retirement Savings Conference: our tax code discourages saving.

Let’s turn to the basics for a moment.

Our income tax system began as a system intended simply to fund the government. Over the years, successive Congresses and Administrations have proposed and enacted both minor changes and major overhauls. We have grafted on more and more components to the point that the system is nearing collapse.

To be sure, many of the components reflect an increasingly complicated world. But many do not. Often changes have been designed to hit a revenue target or to patch a hole, real or perceived. Whatever the case, changes have been made too frequently, without coherent or consistent policy design, with insufficient overall consideration of their effect on our country or its relation to the global economy, and without adequate thought to how each of the new components fits with the others.

In the tax world, we have done exactly the opposite of what the business world has done to increase productivity – a key to the incredible economic growth the county has experienced in the recent past. What is it the business world has done to increase productivity? They’ve simplified. They’ve taken every process down to its constituent parts and cut out the inefficiencies, the points of friction, the drags that prevent the most streamlined operation and the standardization of transactions.

In the tax world, instead of simplifying to increase productivity in compliance and administration, we keep adding complexity – more rules, more limitations, more terms, more conditions, more qualifiers, more provisos, more exceptions. The result is that our system gets slower and slower and more inefficient. We burn more fuel, and emit ever more heat and smoke, and yet with all that burning, there’s less and less light to show for it.

Nowhere is this problem more evident than in the numerous savings vehicles we have in the Code. Instead of simplifying to increase saving, we keep adding complexity – more rules, more limitations, more terms, more conditions, more qualifiers, more provisos, more exceptions. As a result Americans are increasingly disinclined to save, rather than trying to figure out the complex rules.

Two decades ago – before the ’86 Tax Reform Act fixed all sorts of things that weren’t broken – there was one kind of IRA and it worked for everyone. As Matt Fink has noted, from 1980 to 1986, contributions to IRAs rose nearly ten-fold, from $4 billion to $38 billion. Even more significant, however, is that the median income of contributing workers declined from $41,000 in 1982 to $29,000 in 1986.

The ’86 Act added provisos to the simple IRA that limited its availability. These provisos were based on income and pension plan availability. The result: participation dropped. Confusion over eligibility, deductibility, and the benefits of continuing to contribute sidelined many former participants who were still eligible to participate.

The complexity also sidelined our financial institutions whose marketing abilities – coupled with the convenience of payroll deductions or automatic transfers – had made the IRA popular and successful. The limitations, qualifiers, and provisos made it impossible for them to standardize transactions. In short, we told simplicity – and the efficiency and productivity simplicity brings – to take a hike. It has never returned. Instead of going back to basics to fix the decline in participation, we have added more complexity. We now have three versions of the IRA – traditional, nondeductible, and Roth. All operate differently, including with different limitations, qualifiers, and provisos – and, of course, they are mutually exclusive.

Recognizing that more people would be willing to set aside cash for retirement if they knew they could withdraw it in certain circumstances, we made exceptions for certain kinds of withdrawals in certain situations and added more complexity.

As the list of sympathetic withdrawals lengthened, we added new savings accounts for the new purposes. ESAs, QSTPs, MSAs. Hardly a month goes by that someone doesn’t propose yet another account for yet another purpose.

And so the complexity grows, the inability to standardize transactions grows, the cost of administration grows, and the confusion multiplies!

Implicit in all of these complicated provisions are two important points. First, we don’t trust the American taxpayer to make the right decisions, and, second, our tax rules contradict our values.

If we did trust the American taxpayer to make the right decisions for him or herself and his or her family, we wouldn’t need the long list of qualifiers, provisos, and exceptions, backed up by penalties. Penalties, incidentally, that particularly discourage participation by lower and moderate income families. It’s hard enough for people to save today. The last thing we need is some scold hitting the virtuous saver with a penalty because they need the money for some purpose unsanctioned by Washington.

The rules contradict our values because our system penalizes those who save their money instead of spending it. We will only reduce the penalty for those who agree to save, and in fact do save, for the purposes dictated by us here in Washington. This contradiction of our values is so engrained that it has become second nature to us – we don’t realize the effect it’s having.

Take a simple example. Two families – identical except that one of them spends everything they make and the other saves some, whether to buy a new home, for continuing education, for a rainy day, for unexpected emergencies, for their children’s future, or for their own retirement security. Over time, the family that saves will see its tax bill increase relative to the family that spends everything. We justify that on the basis that the family that saved has more income and a greater ability to pay. But the reason they have more income is because they chose to do the right thing. Like the ant in the parable, they worked and saved for their future. Virtue may be its own reward, but we’re going to get less of it if we attach penalties to it. And, mind you, the additional taxes aren’t limited to the tax owed on the savings income. Nor are the penalties for this virtue limited to the tax code.

We need to go back to the drawing board. We need to have faith that the American people know how to do the right thing. The President’s budget proposals for retirement and lifetime savings accounts would do just that.

The proposed simplification of the retirement savings accounts and the addition of a lifetime savings account accessible to all Americans would bring significant simplification benefits. The lifetime savings account, or LSA, will allow everyone to contribute – with no limitations based on age or income status – up to $7,500 per year of after-tax income. LSAs could be used to fund a college education, start a business, buy a first home, save for emergencies, or used for retirement. Earnings would not be subject to income tax and amounts could be withdrawn at any time for any purpose. Think medical savings accounts without losing unused cash at the end of the year. Think education savings accounts without the receipts. LSAs also could be established for children.

The retirement savings account, or RSA, would consolidate traditional IRAs, nondeductible IRAs, and Roth IRAs into a single simple account for retirement savings. Individuals could save up to $7,500 per year of after-tax compensation — regardless of the level of that compensation – for retirement, whether or not they also save in an LSA. Earnings in an RSA would not be subject to income tax provided the earnings are not distributed prior to the owner reaching age 58 or becoming disabled. Individuals would be able to convert existing tax-preferred savings into these new accounts in order to consolidate and simplify their savings.

Confusion and frustration are far too common among individuals trying to save. In 1982, the IRS publication explaining individual retirement accounts was 12 pages long. Now it is 104 pages long. People should not have to worry about the confusing alphabet soup of six different savings accounts and the endless maze of confusing rules. The two simple accounts will have one powerful goal – making saving for everyday life and retirement security easier and more attractive.

Getting rid of the restrictions and qualifiers simplifies marketing and participation for everyone and for every purpose. But make no mistake about it: the real winners here are average Americans. In a matter of less than a decade, the accounts would permit all lower and moderate income Americans to enjoy the benefits of tax-free compounding and freedom from the complexity of Schedule B and Schedule D for all of their savings. This will give more hardworking Americans the chance to enrich their lives and strengthen their retirement security.

Besides simplifying savings for individuals, we need to simplify and rationalize the rules governing employer sponsored retirement plans. Each plan’s purpose is to encourage retirement savings. But different sets of rules for different types of plans and different types of employers needlessly complicate and confuse employers and employees and make more difficult the standardization of transactions that reduces cost. Employer Retirement Savings Accounts, or ERSAs, would promote and vastly simplify employer sponsored retirement plans by consolidating 401(k), SIMPLE 401(k), 403(b), SIMPLE IRAs, SARSEPs, and 457 plans into a single type of plan that could be more easily established and maintained by any employer.

Less than 50% of the work force is covered by a retirement plan. Among small businesses, the coverage is even lower, with estimates ranging between 25 and 33% of the workforce. One look at the complexity of the rules and it is easy to understand why many small businesses would have opted out. We need to change that. We need to simplify the rules to make them accessible for all employers, regardless of size or sophistication.

I think you will find these proposals both sensible and constructive – they will simplify our tax code for employers and individuals, so that all Americans can save more for retirement, and for all their investment needs. We welcome your input on ways to make the proposals even more potent tools to encourage savings. Like the President’s Jobs and Growth plan, and the Tax Relief Act of 2001, this will mean a long term boost for our economy, and greater prosperity and freedom for every American family.

Thank you.”