December 19, 2008
A better bailout alternativeBy Tony Kondaks
Is taxpayer money the only source for bailout funds?
There is an alternative to the bailouts the federal government is meting out to insurance companies, banks, and automakers.
This alternative requires neither one cent of taxpayers' money nor government involvement (save for the enabling legislation) to implement.
The funds are available now, they are plentiful, and the incentive on the part of the owners to use their funds for the bailout can be easily created.
Retirement accounts: $12 trillion
As of March 31, 2008, retirement accounts in the United States totaled about $17 trillion. Because approximately 50-60% of those funds are equity-based, and due to the approximately 50% decrease in the stock market since this benchmark date, we must assume this figure currently to be about $12 trillion.
Retirement accounts include 401(k)s, IRAs, 403(b)s, defined benefit pension plans, etc.
Almost all of that $12 trillion is tax-deferred; that is, no income tax has yet been paid on the funds, whether the contributions came from one's salary or from growth to the funds while within the qualified account.
When those funds are withdrawn (i.e., "distributed" in retirement parlance), they are taxed at the retiree's highest marginal tax rate in the year taken out. This may also include a double tax as pension and IRA distributions are considered income for the purposes of the Threshold Income formula that determines the taxation of one's Social Security benefits.
Funds in an IRA account are considered part of one's estate at the time of death. For those well off, as much as 75% of an IRA's value can be lost in income taxes and estate taxes combined.
Use retirement accounts to fund the bailout
I propose that retirement accounts be used to fund the bailout instead of taxpayer money. Here's how it would work:
The federal government would have to pass legislation enabling funds from individual or professionally managed retirement accounts to be placed in trust in specially designed Super Roth retirement accounts. The underlying investments comprising those funds -- be they CDs, stocks, mutual funds, bonds or whatever -- would not be liquidated. Instead, funds placed in Super Roth accounts would serve as collateral for any monies used to back financial instruments -- such as those toxic mortgage bonds that are creating such financial havoc -- or loans to private enterprises that would otherwise be provided by the government bailout schemes.
Thus, the Super Roth funds would take the place of government bailout monies.
Any funds placed in the Super Roth would, henceforth, be tax-free to the investor, just as is the case with a regular Roth IRA. That is, when the funds are eventually distributed from the account to the investor, they would come out 100% income tax-free. Unlike the regular Roth, the Super Roth would also be estate tax-free.
The Super Roth would have a few other conditions and features attached to it as well:
- unlike a regular Roth IRA which is contributed from after-tax dollars -- that is, funds on which income tax has already been paid -- contributions to the Super Roth could come from tax-deferred dollars (such as those that make up the bulk of the current $12 trillion in retirement accounts). The perceived higher risk of using the funds as collateral for the toxic financial instruments or to back loans to failing car companies is offset by the benefit of not having to pay taxes on the tax-deferred funds used. These tax savings would be equivalent to as much as a 75% discount to the investor who places funds in the Super Roth. In the case of failure and liquidation, the discount may even be higher in certain cases (see discussion on this point below).
- As stated above, any growth to the funds placed in the Super Roth will grow tax-free and, when distributed, will come out tax-free. And not just income-tax-free, as is the case with a regular Roth, but estate tax free as well (which is not the case with a regular Roth). Such a feature will attract billions of dollars from investors who otherwise would lose as much as 75% of their funds to both income and estate taxes, effectively discounting the opportunity cost to a fraction of what it would otherwise be.
- funds from after-tax, non-qualified dollars may also be used (this would be a source of funds in addition to the $12 trillion in qualified retirement accounts). In such cases, the incentive to invest will, again, be income and estate-tax-free distribution. But the attraction of capital gains tax-free distribution, something that is not a consideration for tax-deferred investments, can serve as an additional incentive for the investors with non-qualified monies.
- Regular IRA rules require owners to start a schedule of Required Minimum Distributions each year once they reach age 70 ½. This requirement can be waved for any IRA funds invested in the Super Roth.
- If the toxic instruments on which the Super Roth funds are serving as collateral fail, the government will fund a waiting period of at least five years from initial deposit by the investor until the Super Roth investments are liquidated. This will provide an opportunity for the underlying investments to gain in value, hopefully providing a net value to the retiree above the collateralized value. This will also ensure a "cushioning" of potential one-time wholesale sell-offs of collateralized assets that could occur in the case of a massive failure of one category or block of toxic assets. Including a provision to liquidate the underlying assets over, say, a period of 2-3 years will ensure a minimal negative effect on markets.
- As an additional incentive: if underlying investments placed in the Super Roth have to be liquidated and surrendered, the investor should be given a 100% tax deduction of the original value of the lost investment (or the highest investment value it may have reached while in the Super Roth, whichever is more). In extreme cases this could mean as much as a 115% tax-savings, based upon current marginal income and estate tax rates.
- Any type of funds may be used: CDs, bonds, stocks, mutual funds, cash, money market funds.
- IRA owners can contribute any percentage of their qualified accounts; however, money managers of 401(k)s and defined contribution plans can only contribute a maximum of 25% of the combined value of the funds under their management.
- The Super Roth trusts will be run by professional money managers, not government bureaucrats.
Bailout as a percentage of total retirement funds
Even if as much as $2 trillion in bailout funds are used under the proposed Super Roth scheme, this still only represents less than 20% of all current retirement account holdings.
Government will lose future tax revenue because, henceforth, Super Roth funds and any ensuing growth to them, will be tax-free.
Everyone is up in arms about the government being in the business of bailing out private sector concerns to the tune of not millions, not billions, but trillions of dollars. Government, it is said, should not be in the bailout business:
1) bailouts encourage more demands for bailouts; a slippery slope with no end in sight in which more and more inefficient and unprofitable enterprises will proffer outstretched hands; and
2) government-run bailouts have a higher chance of failing because, by definition, government bureaucrats are ineffective managers that neither answer to share-holders nor have any incentive to run an investment fund properly. And let's be clear: bailouts are investments whether we want to call them that or not...and we, the taxpayers, are the investors. Government managed bailouts are monopolistic, void of any benefit that competition provides to investors in the private investment sector.
The Super Roth eliminates both of those objections: (1) bailouts have been moved to the private sector; government has been removed as everyone's favorite Head Waiter, ever willing to dole out funds to whomever asks; the Super Roth would nip the slippery slope in the bud; and (2) funds will be run by the private sector, not government bureaucrats. Competition amongst Super Roth managers will develop, thus increasing the likelihood of better management directing the money invested.
Tony Kondaks resides in Mesa, Arizona. He has written on taxes, IRAs, and Roth IRAs.