17 January 2018

Obama's Budget Bad for 401(k) Savers

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President Obama's proposed budget for 2015 would be a disaster for the millions of Americans who are underprepared for retirement. This plan would reduce the tax incentives for employers to offer retirement plans to their employees.

Let's examine the backdrop.

Our country's retirement situation is a mess. Social Security is grossly underfunded and is headed for insolvency, yet neither political party has the guts to offer any real solutions.

Corporations killed their pension plans years ago because they couldn't afford them, while government pension schemes are beyond broke and causing havoc in many cities and municipalities.

The largest retirement-savings vehicle in the U.S. is the defined contribution plan—namely, the 401(k) plan. This is a plan in which employees may elect a portion of their paycheck to go into an account earmarked for retirement. They receive a tax deduction for the amount that is saved and will realize the taxes when the money is withdrawn during retirement.

Saving is hard for most of us, but it's not the tax deduction that makes the 401(k) so attractive. The real beauty of the 401(k) is that the money is yanked out of one's paycheck before the worker has a chance to spend it.

If you work for a Fortune 500 company, odds are you have a decent 401(k) plan and Obama's budget won't have much impact on you.

However, if you are like the millions of Americans who work for a small company, this budget may kill your chance for any sort of financial independence during retirement.

Obama's 2015 budget would reduce the tax incentive for business owners to establish and maintain a 401(k) plan. Currently, all employees can participate in a 401(k) plan, and all employees are able to avoid current taxation on the money they place into the plan.

Under Obama's budget plan, higher-income earners would be limited to a tax deduction at the 28 percent level, even if their current income-tax bracket is much higher.

If this budget actually becomes law, a person who is at the highest marginal tax bracket of 39.6 percent (this doesn't include state income taxes or the 3.8 percent Obamacare tax) would only be entitled to a tax deduction equal to those individuals in the 28 percent tax bracket.

So while they would receive only a partial deduction today, when they withdraw the money during retirement, they would be fully taxed at their current tax rate.

This means they would not only pay taxes on some of their contributions today, they are fully taxed when they withdraw the money in the future. This, of course, is double taxation.

Given that most of the high-income taxpayers are business owners, are they really going to want to start a retirement plan that has the very real potential to be both professionally and personally bad for them? Retirement plans are costly to set up and expensive and time-consuming to maintain. In addition to the hard costs, the Department of Labor can walk into a business at any time to audit the plan.

Large corporations have the staff to deal with government regulators, but having one more governmental agency to deal with is tough for small businesses.

The fact is, more Americans work for small businesses than for large corporations. These hardworking folks deserve the same sort of retirement-savings incentives as those who work for a Fortune 500 company. Unfortunately, this bill will deprive those folks of this valuable tool.

So what are some other ways this administration could deal with the looming retirement crisis?

Click here for the full column by Scott Hanson at CNBC.

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