Just after the new year, the 109th U.S. Congress will convene in Washington, D.C. With tax cuts, Social Security reform and the war on terrorism, there are plenty of issues to keep them busy. However, I hope they spend some time helping middle-class families save money.
Currently, there are numerous savings plans that receive preferable tax treatment (IRAs, Roth IRAs, 401k, 403b, 457, 529, SIMPLE, KEOGH, Coverdell ESAs, etc.). For some plans, contributions are tax deductible. Some plans allow penalty-free withdrawals of contributions. All of these plans, however, restrict the use of funds in some way.
This smorgasbord of savings plans--each with its own rules--leads to unnecessary complications. Consider the decisions of a young worker in her twenties. If she saves in a retirement account other than a Roth IRA, she cannot touch her savings until she reaches the age of 59 1/2...more than thirty years away! She will give up access to her money today for the ability to spend it in thirty years. If she doesn't live that long she gives up the money forever.
Consider the decisions of a middle-class family that wants to save money for their children to attend college. However, if a family member becomes seriously ill the family will want to have access to the funds to pay for health care needs. Yet, college savings funds are only allowed to be spent on college.
We should make it both easy and profitable for people to save. I propose that we:
Combine all the tax preferred savings plans into one plan with one set of rules--I call them Individual Savings Accounts (ISAs).
Allow individuals to contribute up to $20,000 per year to their ISA. This is similar to what is allowed under current law.
All contributions and earnings would be tax deferred until the time of withdrawal. Like IRAs and 401k plans, savers would receive an immediate tax benefit.
Allow withdrawals at any time, and for any reason, without a penalty. Most withdrawals would be taxable, however. Essentially, you pay taxes when you choose to spend the money.
Allow tax-free withdrawals for health care or education expenses.
There are numerous benefits to such a plan. First, it is much simpler than the current system. Instead of numerous programs, with numerous rules, there would be only one program with one set of rules. And, these rules are simple. You spend money...you pay more taxes. You save money...you pay less taxes.
Second, this proposal gives savers more control over their finances. Young workers will know they get the tax benefit from saving...but will also have access to their funds if they need them. Families will know that they can save for college, and not be penalized if healthcare emergencies arise.
However, there is a third, even more subtle benefit. By not taxing savings, and taxing the money when it is spent, this proposal works like a consumption tax--which many conservatives (and economists) advocate. Savings are the fuel for economic growth. Savings turn into business investment, which leads to economic growth and higher wages. By rewarding people for saving, we foster economic growth.
Unlike a national sales tax, though, this proposal works within the current income tax structure. A national sales tax--which some advocate--would effectively raise taxes on the middle-class and decrease them for the wealthiest families. In contrast, my proposal creates a consumption tax that helps the middle-class families...not harm them. The wealthiest individuals will still be able to shelter some income, but they will not get a tax break on the backs of middle-class families.
This proposal simplifies the tax code, rewards savings, helps middle-class families afford education and health care, and stimulates the economy. Workers work hard for their money. They should be able to decide how to save money with as few hassles as possible. If Congress adopts this proposal, middle-class families will be able to do just that.
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