Our tax attorneys in San Jose have been closely following Republicans in Congress as they prepare to battle out tax reform and attempt to cut taxes. However, this leaves individuals to wonder who pays for the cuts. A solution currently being considered is an upfront tax on retirement savings. Many individuals in the retirement savings industry are concerned that Congress may decide to “Rothify” employees’ 401(k) contributions, in whole or in part.
The Fate of Future Contributions
Currently, the funds you put in a conventional 401(k) are not taxed when you contribute. Rather, the growth of the money is tax-deferred. However, when you begin withdrawing funds for retirement, these funds are taxed as standard income. The latter is the exact opposite of the way both Roth IRAs and Roth 401(k)s work. With Roth accounts, you make contributions after taxes are paid, but tax-free status comes into play regarding your gains and withdrawals. Should Congress decide to “Rothify” 401(k)s, it could enable them to regard all or some of your future contributions to 401(k) accounts as taxable income during the year the contributions are made.
Nothing New in This Approach
It is not the first time this approach has been considered: in 2014, under then House Ways and Means Committee chairman, Dave Camp, a version of this plan was discussed during conversations focused on tax reform.
Under this plan, it would be possible for you to contribute up to half of the allowed annual contribution limit before taxes. That limit is currently $18,000. Pretax status would also apply to your employer’s match; however, other monies you invest in the fund would be taxable immediately.
Tax Reform or a Fiscal Gimmick?
Because the taxes on long-term savings would be front-loaded under this plan, revenue could be raised in the short term by Rothifying 401(k)s. In fact, it was estimated that the proposal made by Camp in 2014 would raise almost 144 billion dollars over 10 years, seemingly “paying for” the permanent tax cuts desired by Republicans.
I can tell you as a tax attorney, that making such a change would result in lost money over time. This is because money collected by the federal government would decrease once employees begin making tax-free withdrawals upon retirement. According to the Committee for a Responsible Federal Budget, shifting the timing in this manner is little more than a fiscal gimmick. A spokesperson for the Committee stated that the plan would merely produce short-term savings by pushing costs into the future.
These facts and figures, however, do not really tell individuals who are saving for retirement whether the deal would be good or bad. The answer is that no one truly knows.
In a recent blog post, Nevin Adams, who works at the American Retirement Association as communications chief, noted that there is essentially no research that addresses the subject of how employers and workers might react to this plan.
However, this may soon change: The Employee Benefit Research Institute is in the process of studying