One of the most important tools that individuals use to save for retirement is the 401(k) plan, which now faces an uncertain future. With different messages coming from the legislative and executive branches regarding potential changes to tax law considering 401(k)s, many Americans are rightfully worried about what the future holds for this popular investment vehicle.
The issue stems from a $4 trillion deficit in the federal budget due to tax cuts that were passed by Congress toward the end of October 2017. With the tax cuts approved, Congress now faces the challenge of finding money to offset the deficit. Many strategies have been discussed, but that one that has received the most attention could directly affect how Americans save for retirement.
Proposed Changes to Retirement Savings Tax Policy
The tax code has not received a comprehensive update in nearly a generation. The new budget essentially makes a conversation about tax code updates unavoidable. According to the new budget, taxes are approved to be cut by $1.5 trillion. However, the Tax Policy Center estimates that the proposed changes would actually drop federal revenue by $5.5 trillion, which would lead to a $4 trillion deficit.
Shortly after the budget was approved, Congress announced that it was considering lowering the cap on 401(k) contributions quite significantly. Currently, individuals can contribute $18,000 to a 401(k) each year using pre-tax income. In the federal government’s eyes, large contributions result in significantly reduced tax bills.
The idea behind the proposed reduction is the belief that individuals will simply reroute their retirement savings to Roth IRAs and Roth 401(k)s, both of which hold post-tax income. When contributions are made using these investment vehicles, individuals continue to save while the government receives tax money upfront, instead of when people withdraw it. However, the chance that this change will discourage people from saving exists. Shortly after the announcement, President Donald Trump stated that no changes to 401(k) plans would be made and declared the plan an important part of middle-class finances.
Disagreement About the Future of the 401(k) Plan
When Trump responded negatively to the proposal, Representative Kevin Brady, chairman of the House Ways and Means Committee, affirmed that changes to 401(k)s and other retirement products remain a real possibility for upcoming tax reform. Representative Brady expressed his belief that the possible tax reforms would actually encourage people to start saving sooner and ultimately save more.
Part of the rationale behind the potential change comes from the fact that many people with pre-tax retirement accounts now only contribute about $200 a month or even less. Apparently, Congressional representatives are working closely with President Trump to identify a solution that makes fiscal sense.
In a subsequent press conference, President Trump seems to have changed his stance on the issue. Instead of saying that no changes to 401(k) plans would be made, the president stated that he did not want reform to go too far and intended to use potential policy shifts as a negotiating tool to look out for the middle class.
Representative Brady agreed with the president’s sentiment, saying that Trump had given a great deal of input on the potential changes and that no decisions have been made as of yet. Changes, said Brady, would only be implemented if they could strengthen retirement savings programs.
What the Future Might Hold for 401(k) Savings
As previously stated, individuals can currently contribute up to $18,000 per year while under the age of 50 to a 401(k) account. Individuals over the age of 50 can contribute an additional $6,000 in “catch-up contributions.” These contributions grow in a tax-deferred manner.
Already, 2018 should see a limit increase to $18,500 to account for inflation, while the additional $6,000 of catch-up contribution amount will stay the same. According to a New York Times report, the administration may seek to limit this number quite drastically, from $18,500 to $2,400 annually. Representative Brady refused to confirm the report and initially offered little other guidance about how the system might be changed.
While switching to a Roth IRA is a possibility, this type of account already has fairly significant limits. Individuals under can save up to $5,500 in this type of account, with individuals over 50 allowed $1,000 more in catch-up contributions.
Experts have expressed apprehension about lowering the ceiling on 401(k) contributions, saying that Americans already do not save enough. Individuals may not make use of other retirement products, since they do not have the same tax incentive. Leaders from top organizations like Vanguard and Fidelity have spoken out against the proposal, saying that the 401(k) is the cornerstone of saving for low- and middle-income workers.
When Representative Brady spoke again about the proposals, he said that Congress may actually increase the annual contribution limit to $20,000 or higher. However, the Congressman offered little other information and said nothing about the permanence of such a policy change. Clearly, a lot of uncertainty exists and the debate will likely continue for some time. House Speaker Paul Ryan said that he hoped to have a tax bill signed into law by the end of the year, but this goal may not be possible.
In the coming months, working Americans should pay close attention to tax policy debate and considering making their voices heard by contacting their congressional representatives. The decisions made could have a major impact on how and when people can save for retirement in this country.