by Ruby Henley
When they speak, they always tell us to save more and rely less on Social Security. Pushing the narrative that Social Security is struggling with its own issues, be smart and prepare for the future by saving more.
Ah, the golden years…not so golden for the American middle class. Unfortunately, Americans have one of the lowest personal saving rates. As of July 2017, Americans were only saving $3.50 out of every $100 they earned. Sometimes they could not even do that if an emergency hit them. In fact, the American middle class are saving well below the 10% to 15% of earned income that financial advisors recommend workers put away for retirement and an emergency fund.
If you are considered a “middle class worker,” you are about to be sucker-punched by a Republican proposal to alter the treatment of 401(k) contributions, which could make it much harder to get your fair share when retiring. Lets face it, things are not looking so good for the American middle class. Trump or no Trump the middle class are always going to be walking a tight rope between getting by and poverty.
Brigen Winters of the Groom Law Group is working with a group called Save Our Savings Coalition. Members include the AARP, the National Association of Insurance and Financial Advisers, and T. Rowe Price. Frankly, I think those of us concerned with this issue should look to their advice instead of believing what Trump or any politician is saying at this point.
“We remain concerned with reports that some lawmakers may be considering ‘Rothification,’ which would immediately tax retirement plan contributions and could lead to a reduction in savings and plan sponsorship,” the coalition announced in a statement.
Roth IRAs allow for after-tax retirement contributions, whereas 401(k) contributions come before tax.
Winters goes on to argue that taxing contributions up front would have a negative impact on low and middle income Americans and also on employers including small businesses.
The Joint Committee on Taxation, which acts as an advisor to Congress with research on the tax code, has shown that tax-preferred treatment of defined contribution plans will cost 583.6 billion in foregone revenue between 2016 and 2020. This could be very tempting for congress as it looks at ways to fund the tax cuts. Choosing to change the 401(k) tax rules by doing away with the tax deferral benefits of employee 401(k) contributions would be shortsighted and very harmful to the retirement system in the US.
Lets look at the background of the current tax laws concerning contributions to and distributions from 401k plans TODAY.
This is the way the tax laws work with contributions to and distributions from 401(k) plans today.
When an employee contributes to their company’s 401(k) plan, the employer deducts the contribution from the employee’s gross pay before income taxes.
The contribution goes into the retirement plan without having been taxed (except for FICA).
When you retire and start withdrawing funds, the entire amount is taxed, both what you and your employer contributed as well as any earnings you made on the investments.
I did not understand what a “Roth Plan” was before I did this report, but now I understand, and I am concerned. The change that is being considered would make 401(k) plans more like Roth plans. In a Roth plan, your contributions are made with money that has been taxed, but when you withdraw it, then the full withdrawal is tax-free both contributions and earnings.
Many 401(k) plans offer a Roth option today where you can contribute after-tax earnings in return for tax-free distributions when you retire. What is being considered by the current administration, however, would be to do away with tax deferred 401(k) contributions and make all contributions after tax, like Roth plans.
The American people, who work their hands to the bone, should have the option of either making tax-deferred contributions or making after-tax contributions. Further, the American middle class are the ones paying all the taxes, and if anything, they deserved some type of compensation – not less choices in how they save.
We don’t need Congress messing around with our retirement plans! When they start changing the rules in the middle of the game, it definitely indicates they may change the rules again in the future, which only adds more stress to our lives.
If you have funds invested in a Roth plan, but most of your 401(k) money is in the traditional tax-deferred plan, you probably would rather take the present benefit of investing pre-tax dollars and then pay the income tax on withdrawals when you retire at what should be a lower tax rate. You should have that option!
The Trump tax plan, at this point, doesn’t explicitly comment on retirement accounts — such as 401(k) plans and individual retirement accounts — but there are concerns swirling as to how far its mention of eliminating deductions could go. Currently, 401(k) plans are funded with pretax dollars, and assets are only taxed upon withdrawal. If all deductions — except home ownership and charitable giving, the only categories in which administration officials Steven Mnuchin and Gary Cohn said deductions were to remain intact — were to be eliminated, retirement accounts could become more similar to Roth accounts, which are funded with after-tax dollars and allow for tax-free withdrawals.
Such a change might also alter the way people approach their retirement savings, said Tim Steffen, director of financial planning at financial-services firm Robert W. Baird & Co. in Milwaukee. “You can argue that by lowering the tax rates the tax benefit of saving for retirement isn’t as great as it once was,” he said.
For example, if your company gave you a $100 paycheck and you could choose to keep it or put it in your 401(k) plan, you’d get more of that money by putting it in the latter, before it’s taxed. Though it is widely viewed as unlikely to pass muster with Congress, a looming elimination of deductions including those on retirement accounts is something to watch out for, said Mark Hamrick, senior economic analyst at the personal-finance site Bankrate.com.
Published on Sep 15, 2017
Former assistant labor secretary Brad Campbell discusses potential changes to 401(K) and how that fund may be taxed in the future.
by Ruby Henley