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February 02, 2003

Creating Tax-Free Heirs

How's this for tax cut genius? Let's hand a tax cut to the wealthy that doesn't cut revenues during my administration? In fact, let's promote some social value -- say saving for retirement -- and pay for it by gutting revenue for social services in the future.

Well, the first version of this were called Roth IRAs-- retirement accounts that get no tax break now but who accumulate capital gains and dividends tax free and whose distribution upon retirement is also tax free.

Kicking into gear in 2006, under the 2001 tax plan, were Roth 401(k)s which would up the ante by allowing people to have their whole retirement income tax free down the line with a new streamlined version being proposed called Lifetime Savings Accounts.

I wrote a column about the horrors of these kinds of accounts a while ago called 401K Pension Tax Breaks: A $330 Billion Boondoggle for the Rich. As I noted at the time:

Unfortunately, the 401K problem will only gets worse under present law. Last year's tax law introduced a new kind of 401K plan, labeled the Roth 401K after its original Senate sponsor, which will begin in 2006. The innovation of the Roth 401K is to tax the original contribution but to exempt all future increases in value from taxation, forever. This means that upper-income taxpayers will be able to amass vast multi-million dollar fortunes that will be immune from taxation for all time.

The new rules allow owners of these Roth 401K fortunes to not only pass them on tax-free to children and grandchildren, but allow those beneficiaries to continue accumulating and spending money from the Roth accounts free of income tax. Imagine a Roth 401K owner in twenty years with $1 million in his account at death; he leaves $100,000 to each of ten grandchildren. Under the exponential math of compound interest, those grandchildren could each enjoy by some estimates as much as $50-100 million of tax-free income over their lives from these Roth 401K bequests.

Not only does this threaten the bankrupting of funding for government services in the future, but the 401K system will create a whole privileged class of wealthy heirs living in a special tax-free world all their own.

Before that day comes, we need to stop the Roth program and end the $330 billion 401K boondoggle for the wealthy.

Forget the Estate Tax-- these kinds of tax-free savings accounts are a way to leave not just money to children and grandchildren, but leave them the right to tax-free income for the rest of their lives! But combine the elimination of the estate tax with Roth-style savings accounts left to one's heirs, and we have the making of a new kind of inherited plutocracy whose income streams are untouched by taxation.

And remember that parents and grandparents can also build up the tax-free income of their hiers while they are alive by giving directly to their IRA or, now, Lifetime Savings Accounts. By the time every rich kid is 21, they'll likely have something like $300,000 in assets in their Roth-like accounts. Compound that by the time they retire -- or need a home or anything else they can use the accounts for -- and they'll be living pretty tax-free while the tax burden falls only on those earning wages day to day.

Let's be clear, if progressives ignore this danger, we are missing the greatest class war designed on behalf of the non-working rich in American history. This is a plan to leave the investment class completely untaxed over generations, while leaving all tax burdens on those living by wages alone.

For a bit more, read a few professional descriptions of how this works here and here.

Posted by Nathan at February 2, 2003 08:24 AM

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Hidden amongst the details of the Bush plan is a provision to make the Roth 401K plan to be effective immediately.

Also, the Lifetime Savings Accounts (aka Rich Kid Piggy Banks) only augment the education savings accounts and college tuition savings plans that will remain in place.

Yes, it's George Bush, populist.

Posted by: Tim Francis-Wright at February 3, 2003 05:12 PM

So, as I understand it, you're only allowed to put $3K a year into an IRA (including a Roth IRA). This would seem to keep them from being a tax dodge for the rich; for the middle-class maybe.

Is the difference here that contributions aren't capped, and that they're heritable? Or am I just missing something?

Posted by: Matt Weiner at February 4, 2003 09:58 AM

My point is that the new proposals are lifting the yearly contributions much higher. And under the "Roth 401K" proposals, the cap will go up to $15,000 per person a year and (I have to check whether these can go into a Roth form), the employers will be able to put in $30,000.

So potentially, wealthy folks would be able to pack away $45,000 per year either tax-free in the year they save or tax-free forever down the line.

Posted by: Nathan Newman at February 4, 2003 12:04 PM

Roth IRAs (currently limited to $3,000 per year in donations, as Matt W. noted) would get a $7,500 a year limit, and are opened up to the wealthy. Under current law, anyone can open up a nondeductible IRA and pay taxes on any earnings at withdrawal.

My reading of Section 402A is that the Roth 401(k) treatment applies only to employee deferrals, not to any employer matching funds.

Still, with a "Roth ERSA"--the proposed moniker for a Roth 401(k)--a Lifetime Savings Account,
and a Retirement Savings Account, a rich man could put away $15,000 + $7,500 + $7,500 into accounts that would yield tax-free withdrawals of earnings. He could give $7,500 to any number of minor relatives for them to open up their own LSAs (and he could, of course, fund their tuition plans). [His employer could contribute another $30,000 into his account, but it and the earnings would be taxed upon withdrawal]

The net effect is that paying taxes on investment income will be well and truly optional. And we know--or should know--who gets the investment income in this country.

I wrote about this topic this week on my website.

Posted by: Tim Francis-Wright at February 5, 2003 01:59 PM

CBS Marketwatch has a column on this


The Lifetime Savings Account would allow individuals to put aside up to $7,500 a year in after-tax dollars in accounts whose gains grow tax-free -- for themselves, a spouse and their children or anyone else. The Retirement Savings Accounts designed to replace IRAs would allow for the same amount of savings - up from $3,000 to $3,500 now. And the Employer Retirement Savings Accounts that would replace 401(k)-type savings could be funded up to $12,000 this year, and an extra $2,000 for those 50 and over. Added up, that amounts to $73,000 for the family of four -- with all existing income ceilings now imposed on IRAs eliminated.

Additionally, LSAs lack a key element that now defines tax-advantaged savings policies - a penalty for early withdrawal. By allowing unfettered access to that money at any time, LSAs impose no spending disincentive, or the forced discipline to save.

Posted by: Jon H at February 5, 2003 09:50 PM


Can you clarify what wealthy and rich mean? I started working at $20K a year and through hard work I make $110K a year now. Am I rich? Let me know so I can have a party to celebrate.

Posted by: Steve at November 14, 2005 02:54 PM

Steve- Can you pack away $45,000 per year of that $110,000 in a tax-advantaged account? If you have so few other family obligations that you can afford to save that much, you may not be rich but you sure aren't hurting.

Posted by: Nathan Newman at November 14, 2005 04:16 PM

While it is true that there have been penniless innovators, inventors, philosophers and thinkers, it is equally true that until enough wealth was created to enable many to have the time and opportunity to innovate, invent, and think most of the great creations of the human mind lay unborn.

Frankly, I feel NO compulsion to pay ANY taxes although I know there are some legitimate societal services and projects that require a contribution from those served.

The ROTH 401k is a unique opportunity for a working family to capture income otherwise lost to the oh-so-greatful public and use it to build sufficient wealth to enable the next generation the opportunity (only) to use it creatively.

Don't you worry, most of it will be squandered by that next generation - the public schools do such a fine job of educating us on the proper care and feeding of money!!!!

Posted by: Bob, the Tax Guy at January 26, 2006 11:10 PM

Can you clarify what wealthy and rich mean? I started working at $20K a year and through hard work I make $110K a year now. Am I rich? Let me know so I can have a party to celebrate.

Posted by: Amber at March 5, 2006 04:26 AM

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