A friend of the Bush clan for two decades, Republican Congressman Rob Portman is a close ally of President George W. Bush and the man who pushed through important pension reform legislation two years ago. In other words, he’s someone who would surely get a heads up about a major White House initiative on retirement savings, right?
Wrong. The 47-year-old Ohio representative was as shocked as everyone else on Capitol Hill when he learned of the president’s sweeping proposal to overhaul America’s system of savings. Set forth in a dry seven-page Treasury Department press release, the administration’s plans blindsided both congressional leadership and normally plugged-in financial services industry lobbyists, to say nothing of an unsuspecting Washington press corps.
“We didn’t see this coming,” says Portman. “I was surprised.”
Says Representative Earl Pomeroy, a North Dakota Demo-crat and member of the House Ways and Means Committee, “The last time I saw such a significant proposal without any input by principal individuals was the Clinton health plan.”
The administration initiative, which would create a new crop of tax-advantaged savings plans, faces uncertain prospects as Congress remains preoccupied with a potential war with Iraq and a faltering U.S. economic recovery. At the moment, the White House plans, formally part of the president’s budget proposal, are nothing more than a suggestion -- and it’s unclear who, if anyone, will step forward to turn them into legislation and champion their cause in Congress. Treasury officials have made it clear that the president’s proposed $674 million jobs and growth package, which includes tax cuts and various stimulus measures, is more important than the new savings plans.
Still, the Bush proposals have helped create a much-needed national debate about how and why Americans save -- and how the government taxes those savings. Supporters of the proposals argue that they would increase American savings across all income levels and contribute to the administration’s broader effort to spark investment by reducing or eliminating taxes on savings. Critics argue that the plans would disproportionately benefit upper-income taxpayers and cause a decline in the number of qualified plans offered to American workers.
Caught by surprise, key congressional players on retirement issues, led by Portman and Maryland Democratic Representative Benjamin Cardin, are continuing to push their own pension bills, which focus exclusively on promoting retirement planning. Portman and Cardin are talking to the White House about introducing some of their own pension proposals into the president’s growth and jobs plan, which was announced on January 7.
Says Portman, “Savings is a priority, but saving for retirement is more of a priority.”
In their present form, the Bush savings plans would create a substantial new pool of assets. “This is a terrific idea,” says David Weinstein, executive vice president for public policy and regional affairs at Fidelity Investments. Adds Charles Vieth, president of retirement plan services for T. Rowe Price Group: “This is a great opportunity to expand savings. That’s good for individuals, and it’s good for the companies that manage those assets.”
The president’s plans would allow an individual to set aside up to $7,500 a year in each of two new savings accounts, with investment gains and withdrawals made tax-free. Like the Roth IRA, contributions would be funded with aftertax dollars. Unlike the Roth IRA, there would be no age or income limits on the plans. That’s a significant change from most current traditional IRAs, which offer households under a certain income level a tax break for their contribution but tax retirement savings when they are withdrawn.
One plan, the Lifetime Savings Account (LSA), could be used for any purpose, while a second, the Retirement Savings Account (RSA) would closely resemble a Roth IRA and impose penalties on account holders who withdraw money before turning 58. In addition, the Bush initiative would consolidate various employer-sponsored defined contribution plans into one format, called Employer Retirement Savings Accounts (ERSAs). The proposals also call for relaxing the rules governing 401(k)s that encourage employers to ensure that a certain percentage of lower-paid workers participate in the retirement plans.
The new alphabet soup of proposed savings plans reflects several ambitions on the part of the president. Most important, the new plans aim to boost America’s overall savings rate and expand the pool of retirement assets. At the end of 2002, an anxious American public was squirreling away 4.3 percent of its income, the highest level since 1998. The administration also proposes shifting the Internal Revenue Service code away from taxing capital and toward taxing consumption. Finally, the Bush proposals seek to reduce the complexity of what is now a convoluted patchwork of retirement savings options.
“The vehicles now are so confusing,” says Peter Smail, president of Fidelity Employer Services Co. “This greatly simplifies things.”
Concludes James Norris, head of defined benefit and defined contribution saving at Vanguard Group, “This would be the most significant piece of legislation concerning how people save since the 401(k).”
Significant, surely. But would it be effective? Some economists suggest that instead of boosting savings, the plans would merely encourage people to shift their existing savings from taxable to tax-free accounts. Experts are also considering whether the new plans will spur small-business owners to set up ERSAs. Some predict that small-business owners who might have contemplated setting up a retirement plan will be far more inclined to let their employees do it themselves under the new proposals.
Other questions are churning the debate about American savings: Without the lure of an up-front tax deduction, which neither the LSA nor the RSA provides, will some people decide to save less? And if the plans are widely adopted and succeed in boosting retirement savings, will the accumulation of tax-free funds cause a damaging falloff in Treasury tax receipts in the coming decades? The Treasury estimates the plans could produce a tax loss of about $1 billion over the next five years.
Supporters point to one essential virtue of the Bush plans: They provide new and substantial vehicles for tax-free savings and that, they argue, is a very good thing. “The LSA is the bold, visionary piece of this,” says Fidelity’s Weinstein. Although upper-income investors will necessarily reap greater benefits from the new plans for the simple reason that they have more money to save, lower-income taxpayers will be better off as well, say plan proponents. “The ability to save tax-free will have a positive impact on lower- and moderate-income folks,” says Pamela Olson, Treasury assistant secretary for tax policy.
Plan advocates insist that the opportunity to accumulate tax-free interest on savings in the LSA for goals other than retirement will encourage greater thrift overall. But critics say that this flexibility is a double-edged sword: It may encourage some people to squander their savings on needless extravagances.
In assessing the potential impact of the plans, analysts focus particular attention on the small-business sector. That’s because almost 40 percent of American workers are employed by companies with fewer than 100 workers, but only about a third of such employees are covered by a qualified plan. At the same time, 91 percent of those who work for companies with more than 99 workers are covered by a qualified plan.
According to Cerulli Associates, a Boston-based consulting firm, most small companies that do not currently offer retirement plans believe that doing so will be too costly and complex. Because the new ERSAs would be far simpler to establish and administer, many more small businesses will sign on to the new plans, supporters of the Bush proposal believe. “Right now we do an abysmal job with employees in small businesses,” says Treasury’s Olson. “This is who we want to reach out to with the new savings plans.” Mark Niziak, vice president of professional services at New York Life Investment Management Retirement Plan Services, offers the opposing perspective. “Small employers may say, ‘Why should I establish a plan when my employees can fund their own retirement?’” he suggests.
Employer-sponsored plans, including the existing 401(k) and the proposed ERSA, offer employees the opportunity to make pretax contributions. That incentive may be critical in persuading employees to fund their retirement. And if an employer includes a matching contribution, which 95 percent of 401(k) sponsors now do, that further encourages workers to kick in their own money.
Says Ed Ferrigno, vice president of Washington affairs for the Profit Sharing/401(k) Council, a trade group that represents plan sponsors, “Lower-paid employees are less likely to save outside an employer plan if they are not begged, educated and offered a match.”
As much as they might welcome a vigorous discussion of all of these issues, industry executives’ immediate reaction to the Bush proposals was to try to determine their origin and how they so quickly -- and quietly -- made their way onto the administration’s economic agenda.
The strategy was hatched in the Treasury Department, says Olson, who worked on the savings plans for more than a year under the direction of ex-Treasury chief Paul O’Neill. “The Office of Tax Policy came up with this idea a year ago,” she says. “O’Neill approved it.” Following O’Neill’s resignation in December, the proposals were embraced by his successor, John Snow.
To survive, they still need a dedicated sponsor on Capitol Hill. None has appeared as yet.
One small component of the president’s initiative -- calling for the consolidation of various employer plans into one format, the ERSA -- may well make its way into law. There is also support for relaxing discrimination rules requiring that a certain percentage of lower-income employees participate in a company retirement plan. But creating the LSA and the RSA will surely be an uphill battle. “I don’t think the LSA had a half-life of a week,” says Stuart Brahs, chief lobbyist for Principal Financial Group.
Although mutual fund companies and other plan providers see a potential boon in the new savings plans, trade associations that represent plan sponsors -- who are concerned that the new accounts might depress total savings -- have come out against them. Life insurers and other firms that sell variable annuities will likely lobby hard against the Bush proposals. That’s because annuities, which are tax-deferred savings vehicles, would instantly lose their chief advantage, since LSA savings would be tax-free, not merely tax-deferred. “This is a huge intramural war in the financial services industry,” says Ferrigno of the Profit Sharing/401(k) Council.
The vast Bush plan is so extensive that it will almost certainly not pass in its current form. Some elements may survive. Matthew Fink, president of the Investment Company Institute, recalls that when the idea for ERISA was first broached in 1971, few people thought it would ever see the light of day. But three years later president Gerald Ford signed the act into law, and the modern American retirement system was born.
“The administration proposals are a sea change, and when a bill represents a sea change, it rarely gets enacted as it is introduced,” says Fink. “That’s based on 31 years of experience.”
