When benefits adviser Ted Benna thought up a new type of employee savings plan in 1980, the client he created it for rejected the idea as too risky. After all, no one had previously used the unremarkable section of the tax code called 401(k) to defer paying taxes on money that rank-and-file workers set aside for retirement.
So Benna decided to try it out at his own workplace, Johnson Cos., a small consulting firm outside Philadelphia.
Without intending to, Benna set off a revolution. Nearly 40 years later, 401(k) accounts are the most common employer-sponsored retirement plans and a raft on which millions of Americans hope to float through retirement.
Suddenly, they are also at the center of a battle about the tax overhaul promised by President Donald Trump and Republican leaders in Congress. A proposal to slash the amount of money workers can put in tax-deferred retirement accounts set off alarms among savers and members of the financial-services industry, who contend that limiting the tax break would discourage contributions to 401(k) plans.
Many workers once could depend on defined-benefit pensions, but those plans — expensive for employers — have mostly gone the way of the Walkman. Instead, workers were left with the responsibility of saving for retirement themselves, with individual retirement accounts or 401(k)s.
A retirement crisis already looms. Three out of four Americans worry that they will not have enough money to get through their retirements, according to the National Institute on Retirement Security. About 45 percent have not saved a cent toward it.
Trump, sensitive to the firestorm that could be provoked by limits on 401(k) contributions, tweeted there would “be NO change” to this “great and popular middle class tax break” — before conceding it might be a part of legislative horse-trading.
Rep. Kevin Brady of Texas, the principal Republican architect of the tax plan in the House, also scrambled to reassure critics that a rewrite would not undermine retirement savings. “All the focus is on, can we help people save more,” he said.
For all the alarming rhetoric about crushed nest eggs, there are a couple of things to keep in mind.
First, the debate on Capitol Hill is not really about retirement; it’s about lawmakers’ feverish hunt for revenue to finance tax cuts. Second, no matter what happens, it won’t solve the fundamental problem: Many Americans will outlive their savings.
There are several types of subsidized retirement accounts. People who work at larger companies tend to set aside money in a 401(k); they don’t pay taxes until they withdraw funds. By contrast, Americans who open an account known as a Roth get a different kind of break. They pay tax on money before it is deposited, but then get to withdraw it and the subsequent earnings tax-free in the future.
Details of the Republican tax plan have not been released, but the talk has been of imposing a cap of $2,400 a year on tax-deferred contributions to 401(k) plans — a sharp reduction from the current ceiling of $18,000 a year for people younger than 50, and $24,000 for people age 50 and older. There would still be a tax benefit, but it would probably be under a Roth-style structure.
To some people, enjoying the break when they withdraw money instead of when they deposit it may not make a difference. But for Republicans in Washington, D.C., desperately seeking a fast boost in revenue, timing is everything.
Their tax bill includes giant reductions in business taxes. Figuring out how to pay for tax cuts is always a grueling task, but it is especially complicated in today’s partisan atmosphere. Republican lawmakers intend to push through a bill without any Democratic support — but there is a catch. The single-party strategy in this case triggers a rule that requires the policy to have no impact on the budget at the end of 10 years. To make the math work, lawmakers need to come up with the revenue to pay for the cuts sooner rather than later.
That’s where 401(k)s come in. Rather than allow workers to continue delaying their tax payments, the Republican leadership wants to collect tax revenue on most new contributions upfront so they can use it to pay for those expensive corporate tax cuts. That’s the equivalent of a middle-class tax increase.
“It’s just an enormous budget gimmick,” said William Gale of the nonpartisan Tax Policy Center. “It’s raiding future revenues to pay for current tax cuts. This is not a retirement-security story.”
The accounting sleight-of-hand irks Gale, a former economic adviser to President George H.W. Bush, because, he says, it is financially irresponsible. “It’s just government borrowing by another name,” he said. “You’re not really raising revenue,” just changing when it’s collected.”
Source: Seattle Times