Bush Savings Proposal Draws Fire

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President Bush's new savings proposals are radical, controversial and, if enacted, likely to change the way most Americans manage their money. The plans call for special savings accounts that would allow most Americans to avoid ever again paying taxes on money earned as interest, dividends or capital gains. They would also transform America's tax system to one that focuses on consumption, instead of earnings.

But some key members of Congress—both Republicans and Democrats—balked when these proposals were first unveiled, and Bush is unlikely to get a simple rubber stamp from legislators.

Critics charge that the plan would bleed the federal budget, drain retirement savings programs, offer a handout to the wealthy and hurt those at the bottom of the economic spectrum. Congress could spurn the plan altogether, adopt small parts of it or just amend it until it looks like something completely different from the president's proposal.

There's no doubt the plan announced Jan. 31 would offer a good deal to people who already are good savers. It would create three new kinds of savings accounts:

• Lifetime Savings Accounts would allow individuals to set aside as much as $7,500 a year. There would be no tax deduction for contributions, but income earned in the accounts would be tax free forever. Savers could withdraw money from these accounts for any reason whenever they wanted.
• Retirement Savings Accounts would replace individual retirement accounts and Roth IRAs. Working Americans could contribute up to $7,500 a year. Again, there would be no deduction for contributions, but withdrawals used in retirement would be tax free. Individuals could convert their existing IRAs or Roth IRAs into these accounts (paying income taxes on the money coming out of IRAs that had been tax deferred), or they could leave their existing IRAs alone. They'd no longer be allowed to make new contributions to those old accounts.
• Employer Retirement Savings Accounts would be very similar to the 401(k) plans they'd replace. Workers could contribute $12,000 this year (with an additional $2,000 catch-up for workers 50 and older).

Who are the winners? Better-off Americans who have the means to save large amounts could win big, as they could transfer savings into the new accounts. That would make their future earnings tax free, not just to themselves but to their heirs, too, as long as they didn't bump up against estate taxes. And older workers could use the higher contribution limits to play retirement catch-up, too.

But not everyone would be happy. "It's much more advantageous to the higher-income taxpayers than low-income taxpayers," says Barry Picker, a Brooklyn, N.Y., IRA consultant. Retirees who weren't working would not be able to put anything away in the retirement savings accounts. Low-income savers would lose the immediate deduction for contributing to an IRA, and without that, they may not be able to save money at all.

The plan would allow most married couples to put away $30,000 a year, "far more than the vast majority of married people can afford to save," says David Certner, AARP's director of federal affairs. His fear is that people would just use the lifetime accounts and stint on their retirement plans. Pension experts suggest the plans would discourage some employers from offering retirement plans or matching contributions.

The big loser down the road could be the federal budget. The plan would benefit the Treasury in the early years as savers paid taxes on money they transferred from tax-deferred accounts into these new vehicles. But later on, the government could lose billions because Americans will pay less in taxes. That concerns Certner, because it could squeeze the budget at a time when baby boom retirees would already be pressuring the Social Security and Medicare systems. Should that squeeze result in higher taxes on spending, they could hit retirees on fixed incomes the hardest, he says.

Linda Stern is a financial writer based in Washington, D.C.