We’re sitting on the cusp of historic tax reform as a nation. An announcement from President Trump is expected to come on April 26, regarding a new cut in the corporate tax rate — likely to drop to 15%, down from 35%.
Yet the revolution in the way we tax corporations could be funded in part by removing pre-tax benefits from your 401(k) at work.
Will Congress remove one of the main incentives of 401(k) contribution?
One of the primary benefits of a 401(k)s is that it has traditionally offered a way to reduce your taxable income today by letting you make tax-free contributions to a retirement plan with the understanding that the money will be taxed when you withdraw it at the time of retirement to live on.
By contrast, Roth IRAs allow you to save money that’s already been taxed today with the understanding that it won’t be taxed again when you need it in retirement.
Yet The Wall Street Journal‘s Jason Zweig noted a disturbing development in a recent weekly column. In early April, Gary Cohn, director of the White House National Economic Council, appeared before members of the Senate Banking Committee with a dangerous idea: Remove the pre-tax benefits of 401(k) contributions and make the money tax-free in retirement.
That would effectively treat your 401(k) like a Roth IRA from a tax perspective — no tax break today, but a tax-free pot of money down the road.
In all fairness, Zweig notes that it’s not entirely clear how serious the Trump administration is taking this idea.
“The odds are extremely low that this will pass,” consumer expert Clark Howard says. “But for many, if you have the option for a Roth 401(k), you’d be better off doing that anyway.”
A Roth 401(k) doesn’t give you a tax break now, but you can withdraw your contributions and earnings tax-free at the time of retirement.
The reality is this: With the announcement of a corporate tax cut imminent, the administration will have to look for ways to generate additional revenue to compensate for the money that would be lost from the anticipated much lower 15% corporate tax rate.
Taxing money upfront before it goes into a 401(k) would result in $1.5 trillion additional tax revenue over the next decade, according to estimates.
But again, Clark says it’s very unlikely that the way we handle 401(k)s will change.
Keep your pitchfork handy…
This whole discussion about messing with the average working person’s retirement is considered a serious affront by many — something everyday Americans don’t take lightly.
Consider this: While pensions have largely gone the way of the dodo bird for most people, members of Congress get to participate in the Federal Employees Retirement System (FERS).
Under the FERS plan, all members of Congress can contribute to a 401(k) with a match and they also receive a traditional pension.
Meanwhile, the Center for Retirement Research at Boston College finds that only some 13% of employees in our nation have both a 401(k) and a traditional pension.
To add insult to injury, the FERS 401(k) plan that Congress enjoys has a dollar-for-dollar match up to 5%, courtesy of the U.S. taxpayer.
And who funds the pension? You guessed it… that’s funded by taxpayers, too.
In 2015, newly retired members of Congress received an average of $41,316 out of taxpayers’ pockets, according to the Congressional Research Service.
As Jason Zweig notes in closing out his Wall Street Journal column: “If you have a pitchfork in your garage, keep it handy. Your 401(k) might need defending.”
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