October 23, 2017 in Taxes

How tax reform could rattle your retirement planning

How you save for retirement may get a lot harder.

President Donald Trump calls the ongoing Republican drive to cut and reform taxes “the biggest in the history of our country.”

The White House and congressional Republicans have a tax plan framework that would significantly overhaul the tax code for the first time in more than 30 years.

It might also transform the tax break for 401(k) retirement accounts. More details on that have been released.

Here’s what 401(k) savers need to know.

How 401(k) taxes could shift

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.

When you’re in or near retirement, the withdrawals are taxed as ordinary income.

Republican proposals now being considered would cap your tax-deferred contributions at $2,400 annually, according to The Wall Street Journal. Any employer match you receive would not be taxed.

Your savings over $2,400 each year would go into a Roth 401(k), similar to a Roth IRA. That money would be taxed now, not when it’s used for retirement.

A tempting target

Following news coverage of the Republican discussions, Trump tweeted that Americans’ 401(k) plans would undergo “NO change.”

Republicans are said to be considering their 401(k) tax tweak because it would create immediate tax revenue, to be put toward the $1.5 trillion price tag of their current tax cut plan. But the extra revenue isn’t free: Congress would be giving up future tax revenue — when today’s 401(k) contributions are withdrawn.

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.