How the GOP Tax Bill Could Squeeze Your 401(k)

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Proposals floating around Washington to cap the amount that Americans can contribute before taxes to 401(k) plans and individual retirement accounts are unsettling professionals in the retirement industry.

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Republicans are looking for ways to generate revenue to support broad reductions in individual tax rates. One idea is to limit the amount of pretax money households can sock away for retirement saving. Such a move would likely generate significant political blowback but it hasn't been explicitly ruled out, stirring worry among industry lobbyists.

Members of the House Ways and Means Committee are widely expected to release a version of the tax bill by mid-November. Specifics on a wide range of issues remain unclear. Emily Schillinger, a spokeswoman for the Ways and Means Committee, declined to comment.

Lobbyists and others in the retirement and financial services industries who have spoken to congressional staff and committee members say lawmakers are looking at proposals that would allow 401(k) participants to contribute significantly less than what is currently allowed in a traditional tax-deferred 401(k). An often mentioned amount is $2,400 a year. It isn't clear whether that would only apply to 401(k)s or IRAs or both.

Currently, employees under age 50 can save up to $18,000 a year in a 401(k), while those 50 or older can set aside up to $24,000. In an IRA, the annual contribution limits are capped at $5,500 and $6,500 for the same age groupings. The 401(k) limits are scheduled to rise to $18,500 and $24,500 in 2018.

There are two basic types of retirement accounts. With a traditional 401(k) or IRA, account holders generally get to subtract their contributions from their income. But they must pay ordinary income taxes on the money when they withdraw it, typically in retirement when many people are in a lower tax bracket.

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With the second variety, called a Roth 401(k) or Roth IRA, there is no upfront tax deduction but the money grows tax-free.

Under some of the proposals being floated, contributions above the amount set for tax-deferred savings would have to go into a Roth account. The change wouldn't affect existing balances in traditional 401(k)s and IRAs, those people said, and it is likely that any matching contribution from an employer would continue to go into a tax-deferred 401(k) account.

Congress's goal in making the switch is to reduce a tax break that is projected to cut federal revenue by $115.3 billion this fiscal year so the money can be used to pay for lower tax rates. The switch could boost government revenue over the next decade, the period when the tax bill will likely face a $1.5 trillion cost constraint.

Shifting to Roth-style accounts would move tax revenue from the future to the near term. That would help Republicans meet budgetary targets now but could cause problems with a requirement that prevents the tax bill from expanding long-run deficits if they want to pass a bill without Democratic votes under a fast-track process.

With the aim of targeting retirement tax incentives more directly at the middle class, lawmakers may also make changes to an underused tax credit that acts like a government match to retirement savings.

If lawmakers enact these changes, many savers will face a choice between maintaining their current savings rate or their current take-home pay.

For example, someone in the 25% income-tax bracket who puts $1,000 into a traditional 401(k) today would save $250 in taxes -- for a net decline in take-home pay of $750. But if forced to use a Roth instead, that person would lose the $250 tax savings up front and take-home pay would decline by the $1000 that goes into the 401(k).

As a result, many opponents predict all but the wealthy are likely to cut their contributions -- an outcome that would stand to slow the growth of the asset-management industry.

When the White House unveiled the outline of its tax overhaul plan in April, officials promised to preserve existing tax breaks for retirement plans. A more detailed plan released by the White House and congressional leaders in September pledged to retain "tax benefits that encourage work, higher education and retirement security" but left open the possibility of changes to "simplify these benefits to improve their efficiency and effectiveness."

Sen. Rob Portman (R., Ohio) said he was "skeptical" about the idea of lower pretax deferrals for retirement savings.

Mr. Portman said Thursday that he didn't want to make the decision just for revenue reasons.

"I'm deeply concerned about it," he said. "I don't think you want to disincentivize retirement savings in any way right now."

Americans have saved about $7.5 trillion in 401(k)-type accounts, plus $8.4 trillion in individual retirement accounts, according to the Investment Company Institute, a trade group for mutual funds. But some researchers say a significant percentage of Americans haven't saved enough to maintain their standard of living in retirement.

Industry groups have an incentive to keep the status quo and are scrambling to preserve the tax benefits of the current system. Earlier this year, AARP joined with groups representing employers and asset managers -- including Fidelity Investments, T. Rowe Price Group, Inc. and TIAA -- to form Save Our Savings Coalition to lobby for the existing tax treatment of retirement plans.

"Asset managers tend to not like the Roth approach," says Shai Akabas, director of economic policy at the Bipartisan Policy Center in Washington, which is studying the potential impact on savings rates of a Roth switch. Because taxes are taken out at the beginning, he said, assets in retirement accounts -- and the fees these companies collect on them -- are likely to be lower.

Dave Gray, a senior vice president at Fidelity, said a $2,400 limit would give the company a "significant concern" and would essentially require trade-offs between the certainty of the immediate deduction and the prospect of tax-free retirement income.

Mr. Gray, speaking Friday at the U.S. Chamber of Commerce in Washington, said that implementing such a system would be "extremely difficult" and could take the industry 12 to 24 months to implement.

Write to Anne Tergesen at anne.tergesen@wsj.com and Richard Rubin at richard.rubin@wsj.com

(END) Dow Jones Newswires

October 20, 2017 13:33 ET (17:33 GMT)

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