Q&A WITH KENDALL W. KING
Proposed changes to the 401(k) tax break could affect retirement savings
Q: What is the current 401(k) tax break?
A: This is one of largest tax breaks available and is an excellent way to shelter money from taxes. Under current law, you can contribute up to $18,000 to a traditional 401(k) and if you turn 50 or older, you can put in another $6,000, or $24,000 total. This money isn’t taxed when you make the contribution.
Instead, it grows tax-deferred until you start taking funds out in retirement. Future withdrawals at age 59 ½ or older are taxed as regular income.
Q: What’s the proposed legislation to change the 401(k) tax break?
A: As part of overhauling the
U.S. income tax systems, Congress is considering moves that could dramatically reduce the amount you’ll be able to deduct from your taxes for 401(k) contributions next year. However,
President Trump tweeted on
Oct. 23, that this won’t happen.
“There will be NO change to your 401(k). This has always been a great and popular middle-class tax break that works, and it stays!” The most publicized version of the proposed change would make the taxation of 401(k) plans identical to the taxation of Roth IRAs and Roth 401(k)s, which currently offer no tax deduction. Deferring taxes until the money is withdrawn in retirement would no longer be available, but such withdrawals would be tax-free. Eliminating the 401(k) tax break isn’t the only proposal on the table. There are several other alternative proposals that could also change the 401(k) tax break.
Q: Why do they want to change it?
A: Many members in Congress who support tax legislation changes are looking for ways to offset the immediate reductions in tax revenue that would come from lower tax rates on individual and corporate taxes, the increase in the standard deduction, and other promised breaks. 401(k) plan contributions make up a lot of potential tax revenue because of the tax deferral. It was reported by the Joint Committee on Taxation that in 2016, 401(k) plans took away more than $90 billion in tax revenue. The same study reported that this number could increase to $145 billion by 2020 with the current 401(k) tax laws.
Q: How would this impact retirement savers if the tax break is reduced?
A: It’s unclear whether people will save less than they currently are saving. Some workers may be less able to afford to make retirement account contributions with post-tax dollars, so they may reduce their retirement account contributions. What is clear is that taxpayers like being able to choose between paying taxes on their income now or paying taxes later, and many choose both by investing in a 401(k) and a Roth IRA to hedge their bets regarding future tax rates. Losing this ability to hedge increases their risk of not getting all the tax savings the government has promised. Individuals are more likely to save for retirement if they have a workplace retirement plan — and because changes to 401(k) tax policy could discourage employers from offering 401(k) plans — changing the current 401(k) tax structure to a Roth tax structure potentially will result in a lower individual savings rate and greater retirement insecurity for many Americans.