The Investors' Dream Act of 2003

If enacted, Bush's plan could reshape your financial life

Investors, start smiling: President George W. Bush is so eager to see you sock away more money that he has proposed what can only be called the Investors' Dream Act of 2003. The plan puts an array of tax-favored accounts at your disposal. It lets you tap your nest egg whenever you wish rather than delay gratification until retirement. Other good news: You won't be hit with tax penalties if Junior blows his college fund on a Corvette. "This plan is nirvana," gushes Debra L. Morrison, a financial planner in Chatham, N.J.

Too good to be true? Probably. Congressional support for the President's tax proposals is weak, and no doubt they will change much between now and enactment. Still, even if the proposals are scaled back considerably, they will dramatically reshape how we save and invest.

For many people, investing would become practically a tax-free activity under the current proposal. Every American--kids included--could contribute $7,500 annually to a lifetime savings account (LSA) that could be tapped at any time. If you hold a job, or your spouse does, you'd be able to squirrel away an additional $7,500 a year each in a retirement savings account (RSA) that can't be touched until age 59. Although you'd have to fund both accounts with aftertax dollars, you'd never pay taxes on earnings. RSAs would replace today's individual retirement accounts (IRAs).

None of this would prevent you from having a 401(k), which under the act would be renamed the employer retirement savings account (ERSA). Just as you do today, you could set aside up to $12,000 annually ($14,000 for those 50 and up) in pretax dollars and pay taxes when withdrawing funds in retirement.

How would these new accounts affect you? Let's say you and your working spouse are fiftysomethings with grown kids and are a decade away from retirement. You should be earning your highest income, and you're in a good position to save a lot of it. Total up the maximum contributions on the various accounts, and you two could put away as much as $58,000 a year, vs. the $28,000 you can put in tax-favored accounts today.

Already retired? The two of you could benefit by transferring certificates of deposit and other income-generating investments you now keep in taxable accounts to LSAs. You can't move all of it at once, just $7,500 per person per year. Still, you should move as much as possible--because in effect, "it's like a tax-free checking account," says tax adviser Ed Slott of Ed Slott's IRA Advisor, a monthly newsletter.

If you're a parent saving for your kids' college education, the LSA would offer more flexibility than state-sponsored 529 college tuition plans, which are similarly funded with aftertax dollars. Unlike the 529s, the LSA gives you complete say over investment choices. Moreover, you can use the money for any purpose, not just college. And although $7,500 a year may not be enough if your kids are aiming for an elite private university, there's nothing to stop you from contributing to both the LSA and a 529 plan. Still, there is one drawback: Unlike 529 accounts, the LSA belongs to your child, so once he comes of age he can take the money and run.

Since many of these new accounts will be funded with aftertax dollars, your first priority should be putting away pretax dollars, as you already do with a 401(k). "Never pay taxes today that you can pay tomorrow," says David Rhine, regional director of family wealth planning at Sagemark Consulting. At the very least, you should fund the ERSA up to the amount that your employer provides matching contributions. The next best choice is the LSA, because you can withdraw money anytime. Of course, that's a double-edged sword: If you use the dough for splurging, it won't be there for retirement or education.

Figuring out how best to take advantage of the rash of new investment accounts isn't easy, since nothing is yet concrete. Follow their progress through Congress, and be ready with a plan of action the moment they become law.

By Susan Scherreik, with Lewis Braham, in New York

— With assistance by Lewis Braham

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