President Donald Trump has promised that his newly unveiled tax reform plan -- the first significant tax code overhaul in 30 years -- will reduce taxes for the middle-class and corporations.
Continue Reading Below
But it could also have serious ramifications for 401(k) owners and how they're saving for retirement.
Much of the focus so far has been on lowering and reducing the number of tax rates and reshaping popular provisions, like the deduction for state and local taxes.
The Trump administration and Republican congressional leaders has said that it may look at transforming the tax break for 401(k) retirement accounts.
Here’s what 401(k) savers need to know:
How 401(k) taxes could shift
Continue Reading Below
With a traditional 401(k), you build up retirement savings by contributing a portion of your pay before taxes are taken out. Your employer may match all or part of what you put in.
The rules for 2017 allow you to save up to $18,000 in pretax dollars in a 401(k) this year, or $24,000 if you’re over 50. Those contributions are invested in mutual funds and exchange-traded funds offered by your plan, and your savings grow tax free.
You don’t pay Uncle Sam until you take money out of the account when you’re in or near retirement, and the withdrawals are taxed as ordinary income.
The nine-page outline of the Trump tax plan doesn’t mention 401(k)s. But Politico has reported that one idea under consideration would borrow from a 2014 proposal to tax at least a share of your 401(k) contributions upfront.
A tempting target
Essentially, more 401(k) money would be taxed similar to the savings directed into Roth IRAs: You would put in after-tax dollars, then withdraw money tax-free during retirement. There’s already a Roth 401(k) that works this way, and it has been slowly gaining traction.
It wouldn’t be surprising if the White House and Republicans in Congress might have 401(k)s and other defined contribution retirement plans in their sights as they rethink how America taxes its citizens.
These plans cost the federal government around $83 billion during the 2016 fiscal year, amounting to the fourth largest federal tax break, according to the congressional Joint Committee on Taxation.
Requiring that more of the taxes be paid sooner would increase revenue in the near term that could then be used to offset tax cuts elsewhere.
Concerns and criticism
The nonpartisan Committee for a Responsible Federal Budget has long dismissed a 401(k) tax shift as a “budget gimmick.”
And, employers who sponsor 401(k) plans overwhelmingly believe it’s bad idea, according to a survey conducted in May by the Plan Sponsor Council of America, whose members include Microsoft, Exxon Mobil and Charles Schwab.
Plan sponsors worry that tinkering with the current tax advantage of traditional 401(k)s will discourage workers from saving.
“These proposals could impact the more than 100 million Americans who participate in tax-qualified retirement savings plans,” says Jack Towarnicky, the council’s executive director.
What’s at risk
America already has a serious problem with getting people to save for retirement.
A Bankrate survey found that the biggest regret among adults is not saving for retirement early enough. Meanwhile, only 18 percent of American workers are very confident they’ll have enough money for a comfortable retirement, according to a survey from the Employee Benefit Research Institute.
Putting money into savings is difficult enough for many people. Tax reformers in Congress and at the Trump White House may want to be careful not to do anything that makes it feel even harder.