The Trump administration is embarking on new efforts to study and possibly dismantle some of President Obamaâs tax and financial regulations. (April 21)
Lawmakers are looking at dramatically changing these retirement plans.
President Donald Trump was elected, in part, because of his championing of income tax reform, with promises of a simplified structure of tax rates for individuals and lower tax rates on corporations. Yet at no time during the campaign did the president signal that the way his administration would pay for those moves would involve taking away one of the most popular and widely used tax breaks in the income tax system.
Now, though, lawmakers are reportedly looking at removing the upfront tax deduction for traditional 401(k) contributions, and some proposals have even suggested taking away part of the tax deferral that 401(k) plans provide. With most Americans already saving an inadequate amount toward their retirement, changes to the rules would only take away a key incentive for setting money aside for the future and punish those who prudently plan for their retirement.
How Congress might change your 401(k)
One big problem involved in corporate tax reform is that it would be costly. Cutting tax rates from 35% to 15% would result in a drop in revenue, and many lawmakers want to ensure that any tax reform legislation is revenue-neutral. To achieve that, Congress would have to couple tax cuts with ways of raising revenue.
One of the largest tax benefits Americans get comes from the exclusion from income of money that they save in 401(k) plans. According to the latest report from the Joint Committee on Taxation, the exclusion of contributions to and earnings of defined contribution plans cost the federal government more than $90 billion in potential tax revenue in 2016. Estimates have that number rising to $146 billion by 2020, and the total over the five-year period from 2016 to 2020 is almost $584 billion.
The key proposal Congress is reportedly looking at treats all 401(k) contributions as if they were Roth contributions. That would take away upfront tax benefits in exchange for making earnings and appreciation tax-free going forward. By doing so, the federal government believes it could raise $1.5 trillion in additional tax revenue over the next decade, providing an ample source of funding for tax cuts elsewhere.
An even bigger threat could come from measures to change the tax-deferred nature of 401(k)s. Right now, any income and gains your 401(k) generates don’t get taxed until you make withdrawals. But one proposal would impose a 15% tax on annual gains within 401(k) plans. For long-term stock investors, that could put 401(k) plans at a disadvantage to simple taxable accounts, where one can defer capital gains tax simply by not selling shares. Proponents…