Tax Reform May Include Targeting 401(k) to Help With Lost ‘Revenue’

Tax Reform May Include Targeting 401(k) to Help With Lost ‘Revenue’

We all know that besides healthcare, tax reform is one of the bigger ideas on President Donald Trump’s agenda. His administration has been screaming tax cuts while the left cries over lost “revenue.” But instead of cutting spending like any sane person would do when caught in a tight budget, the lawmakers have been looking for ways to make up the lost money.

Targeting a person’s 401(k) has been floated around. A possible change includes taxing the earnings before a person places the money into the retirement fund. This has some worried because it could change your tax bracket once you retire and encourage people not to save as much as they usually do.

As of right now, you do not pay taxes on the money in your 401(k). That tax happens when you take money out of it. CNBC reported that the change could change the amount you would pay in taxes and when you pay said taxes:

Advocates of the current tax-deferred 401(k) plan say that “reducing your taxable income this year with your pre-tax contributions is more valuable to you if your expectation is that you will be in a lower tax bracket in retirement,” as CNBC’s Carla Fried reports.

But Fried warns that this doesn’t always amount to the best financial scenario later on. “If the bulk of your retirement savings are in traditional 401(k) plans and individual retirement accounts, the [required minimum distributions] are likely to keep your rate from plummeting, especially once you add in other income sources such as Social Security and, perhaps, a pension,” she writes.

In short, if you expect to be in a lower income bracket in retirement than you’ll be at the peak of your career, paying taxes up front will cost you. But, as Fried points out, you might end up in a higher income bracket in retirement than you think.

The Washington Examiner said this move is known as Rothification since the 401(k)s would be treated as Roth IRAS.

The Trump administration would likely face opposition from us who have a 401(k), but also from the businesses. From The Washington Examiner:

First, businesses and the retirement planning industry would be at the forefront of that resistance. Many businesses are willing to back a tax bill that eliminate their preferred tax breaks in return for lower rates. But from the financial industry’s perspective, a plan to tax employees’ accounts upfront just to raise revenue on paper could be a bad target.

“We are warning the taxwriters that this could be rolling the dice on retirement security,” said Jill Hoffman, vice president of government affairs for investment management at the Financial Services Roundtable.

Back in 2014, then-Ways and Means Committee Chairman Dave Camp (R-MI)suggested a tax reform bill that included cutting in half contributions to the 401(k) plans. The other half would go into a Roth plan. Employers fear that with a tax up front then people would not save as much. The Washington Examiner explained:

In one scenario, workers could become less interested in employer-sponsored retirement plans altogether, suggested Will Hansen, senior vice president for the ERISA Industry Committee, a group that advocates for large employers on benefits issues. “Those are all just open-end questions right now,” he said.

As with so many other provisions of the tax code, tax preferences for defined-contribution plans enjoy the support of a dedicated coalition that is ready to get to work: The Save Our Savings Coalition, made of several industry groups and large businesses.

Another fear is that this change would not change the change or add as much revenue as the government hopes:

“If the gimmick results in a higher level of debt, then it’s harmful,” said Marc Goldwein, senior policy director for the Committee for a Responsible Federal Budget, a group that advocates for lower deficits.

The issue is that Rothification of 401(k)s would not actually raise revenue, the way that eliminating a tax credit or loophole used by business would. Instead, it would merely shift the timing of when the government received the revenue. As a result, if the tax reform plan, including the gimmick, looked on paper as though it did not add to deficits, could be a big net tax cut. In general, most members of Congress are willing to play such games. But others have resisted similar moves in writing budgets or other legislation.

And in the out years, the Treasury would see lower tax revenue, as people began withdrawing funds from retirement accounts tax-free. “What you’ve basically done is charge the cost of rate reductions to a future generation,” Goldwein said.

Today at The Hill, Robert Reynolds, the president and CEO of Putnam Investments and Great West Financial and owner of Empower Retirement, penned an op-ed against making changes to the 401(k) plans:

Today, savings plans that automatically enroll workers, then automatically escalate their savings to bring them up to rates of 10 percent or more, are already enabling tens of millions of workers to replace 100 percent or more of their work-life incomes. That’s success by any measure, and it depends, above all, on wise plan design, not income. Millions of low and moderate income workers are on track for secure retirement, precisely because the designs of their savings plans make success easy and failure hard. Let’s spread that proven model system-wide.

If Congress would act to ensure savings coverage to all workers, not just some, and support the adoption of successful plan designs, we could solve most of this country’s retirement challenge just by building on and upgrading 401(k)s and other payroll savings plans we already have. The financial and fiscal payoffs of doing that that would be enormous. A 2014 study from Oxford Economics, sponsored by a coalition raging from the U.S. Chamber of Commerce to AARP and the Aspen Institute, found that by offering savings plan access for all American workers and lifting their savings rates to 10 percent and above, the nation’s growth rate and economy could rise by trillions of dollars by 2040.

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