Congress is currently looking to save $4 trillion to offset the tax cuts which were part of the budget which passed on Oct. 26. The trillion dollar question is, where will that money come from? While there are many options, one big item on the chopping block just may be a popular tax break currently used by millions of Americans.
The passing of the budget cleared the way for Congress to fast-track tax reform legislation by rewriting tax code for the first time in a generation. Next, lawmakers will release a tax bill on Nov. 1. The budget that was recently passed allows them to cut taxes by $1.5 trillion. But lawmakers’ plans to cut taxes on businesses and individuals would actually cost around $5.5 trillion, according to the Tax Policy Center.
This discrepancy is the very reason Congress needs to save $4 trillion – a lofty goal, to say the least. The savings would enable lawmakers to incorporate their tax plan into the budget. The burning question is, from where would all of this money come? One of the options is to make some changes to retirement savings rules – which Trump initially appeared to be dead set against.
Next: Here’s what lawmakers may do to your 401(k).
Your 401(k) contribution limit may be sharply cut.
- With Congress looking to save $4 trillion to offset tax cuts, your 401(k) contribution cap may become much lower.
One possible source of raising revenue being discussed to fuel the tax cuts would be sharply lowering the cap for pre-tax contributions to 401(k) retirement plans. The notion is that in turn, people will steer their contributions beyond the capped amount to post-income tax plans such as Roth IRAs or Roth 401(k)s. Such accounts are set up for money contributed to already have been taxed, as opposed to 401(k) plans. This would put more money in the government’s hands now.
After news was made public of possible retirement savings changes, Trump declared on Twitter that there will be no change to 401(k) plans, calling the 401(k) “a great and popular middle-class tax break that works.”
Next: See one lawmaker’s response to Trump’s comment.
Rep. Kevin Brady responds to Trump’s comment.
- Rep. Kevin Brady and Trump volleyed comments back and forth via the press.
Despite Trump’s adamant tweet, House Ways and Means Committee Chairman Kevin Brady (R) suggested the upcoming tax bill could force changes to 401(k) and other retirement savings plans.
The Texas Congressman made the suggestion on Oct. 25. “We think in tax reform we can create incentives for people to save more and save sooner.”
Brady maintained he was “working very closely with the president” on the issue. The Congressman pointed out that many people who have pre-tax retirement accounts currently contribute only $200 a month or less.
Next: Trump responds to Brady’s comments.
Trump may have backpedaled a bit.
- Trump may use 401(k) changes as a negotiating tool.
Trump may have backpedaled somewhat on Oct. 25, when he was questioned by reporters about Brady’s comments. He did not want a proposal to change 401(k) plans to “go too far,” he said, adding he could use such possible changes as a negotiating tool. Brady “knows how important” the retirement plans are, Trump said.
Trump’s comments regarding the matter were given starting at 6:25 in this video of the press conference:
When questioned again later that day by reporters, Brady’s response was, “I’m certainly listening to President Trump,” adding Trump was “incredibly helpful” in compiling the tax reform bill.
“At the end of the day, we’re looking at encouraging people to save more and save early,” Brady said. “We’re looking through a number of ideas No decisions have been made. At the end of the day, retirement will be strengthened or it will remain as is.”
Next: What would changes mean for those with retirement accounts?
Limits may go from $18,000 to just $2,400 per year.
- The New York Times reported such a steep drop may be coming.
As it now stands, if your employer offers a traditional 401(k) plan, you can contribute $18,000 per year if you’re under age 50. Those older than 50 can contribute an additional $6,000, bringing their yearly cap to $24,000 in contributions. The money is not taxed when the contribution is made. Rather, it grows tax-deferred. Taxes are taken out once a person retires and starts to withdraw the money.
Due to inflation, that contribution limit is set to go up slightly in 2018, with the $18,000 allowed changing to $18,500. The $6,000 “catch-up contribution” for those over 50 would remain the same.
However, The New York Times recently reported that the administration may seek to limit pre-tax contributions to 401(k) plans to just $2,400 per year – a sharp decline to say the least.
Brady did not confirm The New York Times’ reported numbers. He would not go into detail about just how the system would change – if it ends up changing at all. So, the answer to “How will this affect me?” is that we do not know yet what exact changes would be made and how they would impact those saving for retirement.
Next: If 401(k) caps are lowered, what are your options for retirement saving?
The Roth IRA is another retirement saving option.
- The total amount you can contribute to a Roth IRA in 2017 is $5,500. People 50 and over can contribute an additional $1,000 for a total of $6,500.
If Congress ends up decreasing the 401(k) annual cap, another option for saving for retirement is a Roth IRA. Unlike a 401(k) and a traditional IRA, a Roth IRA is funded with dollars that have already been taxed. Once the money is in the account, future withdrawals will be tax-free. Every penny you put into the account is yours, since Uncle Sam has already taken income tax on the money.
The beauty of a Roth IRA is since the government does not own any of that money, you can tap your contributions (but not the interest on the contributions) at any time, tax-free and penalty-free. How beneficial saving in a Roth IRA is really depends on the individual. Those who believe they will be in a lower tax bracket at retirement would value a pre-tax plan more, such as a 401(k) or traditional IRA. The opposite is true for those who predict they will be in a higher income tax bracket when retirement comes – as the money was already taxed at a lower rate in prior years.
Next: Read what financial industry experts — and Democrats — are saying about possible 401(k) plan changes.
The experts fear a drop in retirement savings.
- 401(k) plans currently hold an estimated $5.1 trillion.
As of June, 401(k) plans held an estimated $5.1 trillion. Bloomberg interviewed representatives from asset managers such as Fidelity and Vanguard Group, who expressed concern at the proposition of sharply reducing the 401(k) contribution cap. The move may drastically reduce Americans’ already notoriously paltry rate of retirement savings, some fear.
“It would marginalize a key incentive for Americans to save, particularly among low- and middle-income workers,” Dave Gray, a retirement product leader at Fidelity, told Bloomberg. “They will want to preserve take-home pay, which means they are likely to contribute less to a 401(k) and as a result might get less match dollars from their employers.”
Laura Edling, a spokesperson for Vanguard, agreed. Vanguard is “greatly concerned over any legislation that would negatively impact investors’ ability or incentive to save for retirement,” Edling told Bloomberg. “The 401(k) plan is the cornerstone of the future retirement security of millions of Americans.”
Democrats expressed similar concerns about the possible 401(k) cuts negatively impacting middle-class people in a big way. Sen. Ron Wyden (D-Ore.) said as much in a couple of recent tweets:
Republicans in Congress can't help themselves. Going after your 401(k) even after Trump said no. https://t.co/8HKVbjuuS8
— Ron Wyden (@RonWyden) October 25, 2017
Why is it every plan Republicans in Congress put forward to pay for tax cuts for the wealthy reaches straight into middle-class pockets? 🤔
— Ron Wyden (@RonWyden) October 25, 2017
Next: When will we likely find out more about any 401(k) changes?
Paul Ryan has provided his goals.
- Steps may be taken by Thanksgiving and the end of 2017.
The next step in the process will be for Congress to come up with a draft of the tax bill. During that process, more details will likely emerge about what steps would be taken to offset the tax cuts, and if and how that would affect 401(k) accounts.
House Speaker Paul Ryan said on Oct. 24 he would like his chamber to pass the tax bill by Thanksgiving. He ultimately would like to have a bill signed into law by the end of the year. The bill will be crafted by the tax-writing committees in Congress.
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