Winter, 2003 Edition

• Bush Proposes Overhaul of Retirement Savings
• Structuring a Long-Term Care Insurance Policy
• IRS Announces Cost of Living Increases
• Level-Premium Term Remains an Outstanding Value

 

Bush Proposes Overhaul of Retirement Savings

While the nation continues to be focused on terror threats and war with Iraq, the domestic agenda, and specifically the way we save, could be in for a major change. In his budget recently submitted, President Bush proposes what would be the most sweeping overhaul of the retirement savings system in 30 years. The proposals consist of creating new tax-deferred accounts along with simplifying the rules governing employer sponsored plans, such as 401(k)'s.

The New Accounts

Under President Bush's proposal, starting this year, individuals would be able to take advantage of two new types of accounts, the Lifetime Savings Account (LSA) and Retirement Savings Account (RSA).

• Lifetime Savings Account (LSA)

In a Lifetime Savings Account, an individual would be able to contribute up to $7,500 annually, with no limitations because of income. Contributions are made on an after-tax basis (meaning no up-front tax deduction), but earnings and distributions are not subject to tax. Withdrawals from the LSA can be made at any time and for any purpose. The minimum distribution rules that apply to traditional IRA's and qualified plans would not apply.

• Retirement Savings Account (RSA)

All types of Individual Retirement Accounts (IRA) would be replaced by the Retirement Savings Account. The maximum annual contribution to an RSA is $7,500 and is available to all individuals who earn at least $7,500 per year. As with the LSA, the contributions are not deductible up-front, but the earnings and distributions are generally tax-free. The exception is that distributions made prior to attaining age 58 would be subject to tax. The minimum distribution rules would not apply.

The two new accounts may be both be funded, meaning that one could contribute up to $15,000 annually to these tax-advantaged accounts.

Changes to Employer Sponsored Plans

There is a third type of new account, which would consolidate various types of employer sponsored plans into an Employer Sponsored Savings Account (ERSA). Starting in 2004, all 401(k), 403(b), 457, SIMPLE and SARSEPS, would be technically becomes ERSA's and subject to the same rules. The ERSA would generally conform to the existing rules for 401(k) plans, except that the nondiscrimination testing and other technical rules would be simplified or eliminated.

Included in the proposals are that the "Top-Heavy" rules – which require minimum contributions and vesting for many small plans -- would be repealed. Also, popular plan designs that use permitted disparity and cross-testing could no longer be used.

What is the Impact?

If enacted, the impact on the way we save for current goals and for retirement, cannot be underestimated. The new LSA and RSA accounts, along with the President's proposal for eliminating the tax on dividends, goes a long way toward shielding all investment income from federal taxation. Also, the shift in retirement savings would swing towards the individual and away from employer sponsored plans. Despite a stated goal of expanding the number of small employers to sponsor 401(k) Plans by making them "simpler," many analysts believe that the incentives towards saving on an individual basis will actually result in those employers moving away from sponsoring such plans.

Will It Pass?

Early indications are that there is apprehension in both parties about passing these sweeping changes. Although the Treasury Department projects that the new LSA and RSA accounts would actually generate taxes the short run, many are worried about the revenue shortfall over the long term. Also, as mentioned above, there is the fear that small and medium-sized business owners would decide to fund their own savings through use of the LSA and RSA instead of providing plans for their employees. Over the coming weeks, it should become clear as to whether the proposals, in whole or in part, have a chance to become law.

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Structuring a Long-Term Care Insurance Policy

Long-Term Care Insurance is a very important area which has received a great deal of attention of late.

The need for this type of coverage is obvious: the great majority of individuals (even professionals and executives) will fall in the "gray zone" between having assets low enough to be covered through Medicaid, and high enough to be able to afford the cost of a long-term nursing home stay (recent statistics indicate that the current cost can be expected to be as high as $75,000 per year and is increasing steadily).

There are many facets to a Long-Term Care Insurance policy. The most obvious is the amount of the daily benefit, but there are a number of other critical provisions, including the Elimination Period, the Benefit Period, Inflation coverage, and coverage outside a nursing home. These provisions can be defined as follows:

Elimination Period - this is the "qualification period," the number of days during which the policy definitions for coverage must be satisfied before benefits begin.

Benefit Period - this is the length of time benefits are payable.

Inflation Coverage - most insurance companies offer either a "Simple" or a "Compound" Inflation benefit. There is a very real difference between Simple and Compound Inflation provisions. Over the long run, the Compound Inflation definition provides a significantly higher benefit. It does, however, carry a substantially higher cost.

Home Care Coverage - the basic coverage of most Long-Term Care Insurance policies pays a benefit when in a Nursing Home or Assisted Living Facility. An optional benefit offered by most insurance companies provides coverage while at home. One type of provision in this area covers services provided by a representative of a licensed agency; another covers services at home, regardless who provides the care, including family or friends. The latter benefit is, of course, a fairly expensive one.

Experience shows that in requesting information regarding a Long-Term Care Insurance policy, many individuals focus on the "best" coverage - a high daily benefit, a short Elimination Period, unlimited Benefit Period, Compound Inflation, and full Home Care. Unfortunately, even at relatively young ages (i.e., in one's forties or early fifties), such a policy carries a high cost. By the time an individual is in his or her sixties or even seventies, the cost of such a policy design can be prohibitive.

Perhaps the best strategy in the Long-Term Care area is to establish a "middle-ground" policy, which may not have all of the "bells and whistles," but which will nonetheless provide a good level of coverage. This might involve, for example, a 90-day Elimination Period, a five or six year Benefit Period, "Simple" Inflation coverage, and coverage of "Professional Care" at home.

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IRS Announces Cost of Living Increases

The IRS has announced the plan limit cost of living increases for 2003.

	2002	2003
Taxable Wage Base	$84,900	$87,000
Includable Compensation Limit	$200,000	$200,000
401(k)/403(b) Deferral Limit	$11,000	$12,000
401(k)/403(b), 457 Catch-up Limit	$1,000	$2,000
Defined Contribution 415 Limit	$40,000	$40,000
Defined Benefit 415 Limit	$160,000	$160,000
SIMPLE Deferral Limit	$7,000	$8,000
SIMPLE 401(k) & IRA Catch-up Limit	$500	$1,000
Highly Compensated Employee	$90,000	$90,000
SEP Compensation Limit	$450	$450
457 Deferral Limit	$11,000	$12,000

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Level-Premium Term Remains an Outstanding Value

Several years ago many leading insurance carriers introduced term insurance policies with premiums guaranteed not to increase for up to twenty years. For healthy non-smokers, the level premiums were extremely competitive.

More recently, there was concern that insurers could not continue to sell twenty-year, level-premium term insurance policies with competitive premiums. This was due to a new "model regulation" ("Title XXX") adopted by the National Association of Insurance Commissioners and established by many states.

However, now that some time has passed since Title XXX became effective, it is clear that there has not been a major impact on level-premium term costs. While some companies have raised their earlier rates, and others have pulled back their policies altogether, many leading insurance companies continue to offer attractive rates on level-premium term insurance policies.

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This publication is not meant to provide legal or other professional advice. It is suggested that a tax advisor be contacted to review applicable areas discussed herein. All rights reserved.