If last year's federal budget process teaches anything, it's this: Nothing's a sure thing.
True, several of last year's most interesting proposed items — dividend and capital gains tax reductions, for instance — made it into the final budget. But several attractive components ended up on the cutting-room floor.
Still, those advisors who did some planning based on the proposals had a running start on the final budget, and that surely reflected well on them when clients came calling about how the actual budget would impact them.
With this in mind, let's have a go at this year's proposals:
Props to 2005
Overall, there weren't too many surprises with this year's proposed budget. As expected, it calls for permanent extension of the tax cuts from the tax-relief packages approved in 2001 and 2003. These include the reduction of dividend and capital gains taxes, as well as a permanent repeal of the estate tax.
All of these tax cuts were temporary and would otherwise fully expire by 2011 and 2013. While President Bush maintains this is critical to keep the economy strong, there are dissenting voices in Congress, thanks largely to the record budget deficit, which is estimated to reach $521 billion for the 2004 fiscal year ending Oct. 1, 2004.
In terms of financial planning opportunities, the establishment of new Lifetime Savings Accounts, Retirement Savings Accounts and Employer Retirement Savings Accounts — initially proposed in last year's budget — would be good news for the financial community.
Here is a summary of the three plans and the implications for advisors and clients:
Lifetime Savings Accounts (LSA)
Individuals could save up to $5,000 a year (indexed for inflation) in an LSA and have their earnings grow tax-free. Though there are no age or income limitations, contributions are not tax deductible. Withdrawals could occur at any time, for any reason, and would be entirely tax-free. Clients with Coverdell Education Savings Accounts or Qualified Tuition Plans could continue to contribute to them under the current law or roll them into an LSA. Health Savings Accounts and Archer Medical Savings Accounts would be retained.
Retirement Savings Accounts (RSA)
Annual $5,000 contributions can be made to RSAs as well, again indexed for inflation. Like the LSA, there are no tax deductions, age or income restrictions, although a person could not contribute more than his or her annual compensation. Like Roth IRAs today, there will be no minimum required distributions. In addition, there are no tax implications on withdrawals made after age 58, or in the case of death or disability. Roth IRAs would be renamed RSAs. Contributions could no longer be made to traditional IRAs after 2004, although clients would have the option of maintaining the account until it is depleted. They would also have the option of converting their IRAs to an RSA by paying any applicable taxes for the conversion. Whether advisors should choose converting an IRA to an RSA would largely depend on a client's age and the tax implications they would encounter.
Employer Retirement Savings Accounts (ERSA)
ERSAs are an attempt to simplify and streamline the myriad employer-sponsored retirement accounts by replacing 401(k), SIMPLE 401(k), 403(b), and 457 employer-based defined-contribution accounts. ERSAs would follow the existing rules for 401(k) plans, in which employees can defer wages up to $13,000 in 2004, $14,000 in 2005 and $15,000 thereafter, with workers 50 and older able to make a catch-up contribution of another $3,000 in 2004, $4,000 in 2005 and $5,000 after 2006. Existing employer retirement savings programs would be converted to the new ERSA. In a change from last year's ERSA proposal, employers with 10 or fewer employees could fund accounts by making contributions to a custodial account, similar to the current IRA. This would be a benefit for small employers and their employees who are not currently covered by a tax-advantaged retirement plan.
The Future of the AMT?
If there was ever a political minefield, the alternative minimum tax (AMT) is it. Established more than 30 years ago, the AMT was introduced to stop people with extremely high incomes from avoiding their share of taxes. However, over the years more and more people have been snared by the AMT. According to the Urban-Brookings Tax Policy Center, the AMT will apply to 12.7 million taxpayers in 2005 and 33 million by 2010.
A much-needed overhaul of the AMT was not included in the 2005 budget. Rather, it calls for a one-year extension of the temporary exemption increases through 2005. And unless changes are made, in 2006 the exemptions will revert to levels even lower than was the case during the 2002 tax year. President Bush's proposed budget calls on the Treasury to review the AMT and to propose a longer-term solution to include in the 2006 budget.
Other Proposals of Note
Contained within the proposed budget, which was more than 200 pages long, were several other recommendations. Some of the more noteworthy include:
Above-the-line deductions for premiums paid on high-deductible health plans.
Charitable distributions from IRAs starting at age 65.
The elimination of the “kiddie tax.”
Capital gains simplification (changes to the 25 percent and 28 percent rules).
Rules to avoid abusive 529 plan usage.
Though it's anyone's guess what will and won't be included in the final budget, there's no doubt that some proposed measures will result in bona fide financial planning opportunities for clients. As the political debate wages in Washington, take a little time to prepare. Clients will be thankful come October.
Susan L. Hirshman is vice president at JPMorgan Fleming Asset Management. jpmorganfleming.com