If you like the income tax
reduction you get for your 401(k) contribution then make sure to max out now,
because you may not get the chance in the future.
Tax reform proposals of past
years from both political parties have targeted the break people get for
401(k)s because it is a gigantic source of untaxed money – perhaps more than
$580 billion over five years, according to a 2016 Joint Committee on Taxation
estimate.
The Tax Policy Center suggests
that Congress needs to find $2.4 trillion over 10 years to avoid increasing the
deficit with the current tax reform proposal. So the temptation to end the 401(k)
tax break could be intense. Currently, 401(k) contributions come from
pre-tax earnings, and the government waits until you take the money out in
retirement to tax it and the returns it has earned.
If Congress gets rid of this
system, saving for retirement would be more like saving in a Roth IRA or Roth
401(k). With a Roth, you do not get any tax benefit when you
contribute, but the money grows tax-free in the accounts. These accounts are
also not subject to required minimum distributions, which retirees must take
from 401(k)s beginning at age 70 1/2.
Roth rules can be a great benefit
because people can count on every cent after retirement without worrying about
Uncle Sam taxing it. Retirees also are not forced to spend their nest egg, so
they can pass it along to heirs with fewer restrictions if they have money left
over.
It is not clear, however, how the
fine print would shake out, because there is no specific proposal on the table
yet from Congress. Nevertheless, retirement saving advocates are bracing for a
potential fight over preserving the 401(k) system’s tax breaks as negotiations
over tax reform progress. They know Congress will start looking for sources of
billions of dollars so it can cut taxes without adding to the nation’s budget
deficits, notes Brigen Winters, an attorney with Groom Law Group and lobbyist
for 401(k) advocates such as the Plan Sponsor Council of America.
Jack VanDerhei, research director
for the Employee Benefit Research Institute, is already studying the potential
impact, so he is ready at any time.
The big fear among experts like
Winters and VanDerhei is that if people cannot contribute pre-tax money to their
401(k), they will cut back on saving and the nation’s looming retirement
savings crisis will worsen. Americans already are saving so little that 52
percent of Americans are on track to struggle in retirement, according to the
Center for Retirement Research at Boston College.
The way it works now takes some
sting out of saving. For every $1,000 a person in the 25 percent tax bracket
socks away, they pay $250 less in taxes, notes the H&R Block Tax Institute.
If that money cannot go in pre-tax anymore, they would need to pay tax on all
of their income and their take-home pay would diminish.
People do not like to see their
take-home pay slip at all, says Aron Szapiro, director of Morningstar Public
Policy Research. He calculated that a 30-year-old earning $50,000 and now
saving 10 percent of pay, would cut savings to 7.5 percent to maintain the same
level of take-home income while working. By retirement, the reduced
savings level would lower total contributions to the nest egg to $230,400 from
$307,200. And that person would have only about $28,400 for living
expenses compared with $30,800, Szapiro found.
Szapiro notes that young workers
could ultimately benefit from the Roth treatment if their pay takes a big jump
during their careers and they end up with a lot more income when they are
retired than when they were young.
But he thinks most people miss an
important point: The tax breaks people receive on 401(k) savings in the
current system give them the financial leeway to save more early in life.
“If you take that away, people
are going to say: why should I bother to contribute?'” says Szapiro. “It will
be hard to get people to act, and that would be very bad for people in
retirement.”