Don’t bet on that tax-free Trump savings account just yet. Here’s why

Don’t bet the house on a proposed tax incentive from the White House for investing — at least not yet.

As campaigning around the 2020 presidential election heats up, President Donald Trump is weighing a round of tax ideas, including a plan to encourage American households to invest in the stock market.

One concept would allow families earning up to $200,000 to invest as much as $10,000 on a tax-free basis in an account and have it accumulate without being subject to tax, sources told CNBC last week.

Further details emerged on Tuesday in a Wall Street Journal opinion piece, authored by Stephen Moore, a former Trump economic advisor, and Adam Michel, senior policy analyst for the Heritage Foundation.

The two had proposed the idea — which Michel said is fluid — to the president.

“The White House is studying numerous proposals that will benefit the middle class and the American worker and promote long-term economic growth,” said Judd Deere, deputy press secretary at the White House.

“It would operate like retirement savings in that it’s free of taxes on any growth,” said Michel in an interview with CNBC. “It gives folks more optionality on what they should be saving for.”

Enrollment would be voluntary.

The idea has appeal, considering that 4 in 10 adults said they would borrow to cover a surprise bill, according to Bankrate.com.

Still, policy experts and financial advisors question whether the proposal is the most effective way to ramp up savings.

“I like the idea of a universal savings account, so I’m sympathetic to that argument,” said Nicole Kaeding, vice president of policy promotion at the National Taxpayers Union Foundation.

“But we have a large number of tax-advantaged accounts in the U.S. for education, retirement and health care — and they are complex,” she said.

Universal savings accounts— like this concept — and other savings plans have garnered attention in Washington before. In particular, universal savings accounts have had bipartisan support going back as far as the Clinton administration.

The idea pitched to the Trump administration could be modeled like a Roth IRA account — where contributions are taxed in the present, while growth and distributions are tax-free, Michel said

Alternatively, it could look like a traditional 401(k), in that contributions escape income tax in the present, balances grow tax-deferred, but future distributions are levied, he said.

How and when these accounts are taxed matters for federal revenue and for savers themselves, said Kaeding.

“Picking a traditional IRA versus a Roth is based on the assumption of tax rates changing over time,” she said.

The key difference between this newly proposed account and other existing retirement savings plans is that there’s no penalty or restriction for using the proceeds. The money can be used for any purpose at any time.

“If you have an emergency account you can use, it might dissuade you from tapping into a traditional retirement account that would levy you with penalties,” said Garrett Watson, senior policy analyst at the Tax Foundation.

Consider that a 10% penalty and income taxes apply if you touch your IRA or 401(k) prior to age 59½.

“For lower-income people and young people who are hesitant to lock their money up for specific focuses or amounts of time, this serves as an on-ramp for the existing savings system,” said Michel.

Though the proposal aims to reach middle- to lower-income households, it’s no secret wealthier savers are more likely to bulk up on tax-favored accounts.

As of 2016, about 4.66 million taxpayers were able to max out their 401(k) plan contributions — $18,000 at the time, with a $6,000 catch-up contribution for those  over age 50, according to IRS data.

Of these, 3.4 million taxpayers reported 2016 adjusted gross income between $100,000 to $499,999, the IRS found.

“You’re pointing at a problem where a large fraction of Americans doesn’t have savings, but then you come up with a tool to reward people for doing something they would do anyway,” said Mark Mazur, director of the Urban-Brookings Tax Policy Center.

There’s also the question of whether such an account would help the lowest-income households.

“The approach assumes that people aren’t saving and investing because they’ve made a choice not to do so,” said Wamhoff of the Institute. “The actual issue is that people don’t have the money to save and invest.”

Gridlock in Congress would present a major hurdle for this proposal.

Policy experts and financial advisors point to other fixes that might be easier to execute, as they already exist.

Expanding tax credits. Low-income households would benefit more from refundable tax credits — including the earned income tax credit, Wamhoff said.

“It may help offset some of the other taxes you pay, including sales, property and payroll taxes,” Wamhoff said. “Those taxes hit low income people harder.”

Boosting the saver’s credit — which can equal up to 50% of your retirement plan or IRA contributions, based on your adjusted gross income — can also incentivize savings among lower income households and provide tax relief, Kaeding said.

Getting the most use of accounts already available. “We have a lot of best practices out there, including automatic enrollment and automatic escalation,” said Jamie Hopkins, director of retirement research at Carson Group.

Indeed, workplace retirement plans that automatically enroll new hires have participation rates exceeding 90%, according to data from Vanguard.

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Meanwhile plans that required workers to opt-in had participation rates of about 47% among new hires, Vanguard found.

“If you want more people saving, encourage this to be more broadly adopted to get people to save,” Hopkins said. This would include encouraging state-administered IRAs and automatic enrollment into those accounts, he said.

Focusing on building cash reserves first. “Are we encouraging people to save, or are we encouraging people to invest in the stock market?” asked Diahann Lassus, CPA and co-founder of Lassus Wherley in New Providence, New Jersey.

Create your cash backstop before embracing the long-term risk and reward of investing in stocks.

“The incentive should be on the savings side, and the next level is allocating the dollars and having them work for you in the most effective way,” she said.