State and Local Government Employee Deferred Comp Plans to Get Roth Option

Thanks to 403b-Wise for this.  A little-known provision was tucked into the Senate version of the Iraq supplemental bill by Senator Ron Wyden (D-OR).  It allows state and local government employees who participate in Section 457 "deferred compensation" plans to direct their elective deferrals in as "Roth contributions."

This allows state and local government employees to have the same choice of pre-tax or after-tax (Roth) deferrals that most other Americans covered by a workplace retirement plan has.

Below is the text of the law change:

(f) Participants in Government Section 457 Plans Allowed to Treat Elective Deferrals as Roth Contributions-

(1) IN GENERAL- Section 402A(e)(1) of the Internal Revenue Code of 1986 (defining applicable retirement plan) is amended by striking `and' at the end of subparagraph (A), by striking the period at the end of subparagraph (B) and inserting `, and', and by adding at the end the following:

`(C) an eligible deferred compensation plan (as defined in section 457(b)) of an eligible employer described in section 457(e)(1)(A).'.

(2) ELECTIVE DEFERRALS- Section 402A(e)(2) of the Internal Revenue Code of 1986 (defining elective deferral) is amended to read as follows:

`(2) ELECTIVE DEFERRAL- The term `elective deferral' means--

`(A) any elective deferral described in subparagraph (A) or (C) of section 402(g)(3), and

`(B) any elective deferral of compensation by an individual under an eligible deferred compensation plan (as defined in section 457(b)) of an eligible employer described in section 457(e)(1)(A).'.

(3) EFFECTIVE DATE- The amendments made by this subsection shall apply to taxable years beginning after December 31, 2007.

This means that all types of elective deferral arrangements--401(k)s, 403(b)s, and government 457 plans--can offer participants a choice of taking the tax break now (the traditional arrangement), or never paying taxes on the growth (the so-called "Roth" method).

It's important to note that the language of this bill would apply only to employees of state governments and municipalities.

While this bill will likely be vetoed by President Bush, this provision will certainly be in whatever makes it out of Congress.  Because the scorekeepers assume that some people will decide to switch over from pre-tax deferrals to Roth deferrals, this provision actually raises $1 billion over ten years.

While they're at it, Congress out to allow Roth options for all sorts of retirement savings vehicles, including:

• defined benefit pension contributions
• employer matches on 401(k) and 403(b) plans
• SEPs and SARSEPS
• employer matches on SIMPLE IRAs and SIMPLE 401(k)s
• executive deferred compensation
• "retroactive" Roth conversions on built-up pension balances

If all tax-advantaged savings going forward were Roth-style only, and if prior contributions were caught up to this treatment, there would be a much more neutral treatment of savings in the code.  Since all buildup of dollars in these accounts are tax-free, most middle-income Americans could effectively-exempt themselves from the double taxation of capital gains and dividends.

So long as we're dreaming, here is what an ideal arrangement would look like if fully-implemented.  Let's take Bob as our case study.  Bob makes $50,000 per year, and has lots of accounts, including:

1. A Social Security personal savings account.  Bob and his employer put 10% of his salary in here every month, and Bob invests the money in a lifecycle account.
2. An Employer Retirement Savings Account.  Bob puts in 5% of his income (Roth deferral), and is matched 5% by his employer (Roth match).
3. A Retirement Savings Account.  Bob could put in up to $5,000 (Roth treatment), but he's already saving enough for retirement between Social Security and his ERSA.  So, this account is merely a rollover from the ERSAs in Bob's old jobs.  He has the money invested in a stock index fund.
4. A Lifetime Savings Account.  Bob is saving up for his first home, so he puts 5% of his income into this account (Roth-style), which grows tax-free for any purpose.  If he has any extra money at the end of the month, this goes in here as well.
5. A Health Savings Account.  Bob gets health care from his employer.  His boss picks up the premium costs, and matches him dollar-for-dollar on HSA contributions, up to $1000 per year.  Bob chooses to put in $1000 (easily giving him a nest egg to supplement his $1500 deductible exposure).

Ah, to dream.