Financial industry groups and Democratic lawmakers are concerned that Republicans’ forthcoming tax-reform bill could make a big change to the taxing of retirement funds.
Stakeholders say they’ve heard that Republicans are considering significantly lowering the amount of money people can tuck into their traditional 401(k) plans on a pretax basis.
Currently, people under the age of 50 can contribute up to $18,000 annually to their traditional 401(k) plans. Those contributions are paid before taxes, meaning people don’t pay taxes on the money until they pull it out of their account.
The potential change that people following the tax bill are hearing about would lower the maximum annual contribution to $2,400. Amounts over $2,400 could be put into Roth 401(k)s, where the money is taxed upfront but not when it’s withdrawn.
It’s unclear how seriously lawmakers are considering reducing the cap on pretax contributions to 401(k)s. But industry groups are worried that dramatically lowering it would reduce the amount that people save for their retirement.
Jill Hoffman, vice president of government affairs at the Financial Services Roundtable, said that this option is “something that’s a cause of great concern” both for those managing retirement plans and for those who are recipients.
The tax framework congressional GOP leaders and the White House released last month said that legislation would retain tax benefits that encourage retirement security and that lawmakers were encouraged to simplify the benefits.
“Tax reform will aim to maintain or raise retirement plan participation of workers and the resources available for retirement,” the document states.
Emily Schillinger, a spokeswoman for House Ways and Means Committee Republicans, said that “members are developing pro-growth tax reform policies that will encourage and support retirement savings for all Americans.”
Lowering the cap on pretax contributions would raise revenue in the short-term, which would help lawmakers pay for lowering tax rates. Under the budget resolution that Senate Republicans approved Thursday, a tax-reform bill can’t add more than $1.5 trillion to the deficit over 10 years.
But critics of a reduction in the 401(k) limit say that so-called “Rothification” is a budget gimmick that would raise revenue temporarily, but lower it in the long run.
While employers can currently give workers the option of choosing between traditional 401(k)s or “Roth” accounts, most workers choose the former, where the money is deposited on a pretax basis.
According to the Investment Company Institute (ICI), about 55 million Americans participate in 401(k) plans, and the plans hold about $5 trillion in assets. The group found that 80 percent of households with 401(k)s and other types of defined-contribution retirement plans think the tax treatment of the plans is a big motivator for contributing.
ICI, Financial Services Roundtable, the AARP and other groups have formed a coalition called Save Our Savings in order to fight to protect retirement savings in the tax-reform debate.
A person who works closely with the coalition said that there’s a fear that if Congress caps pretax contributions at $2,400, “then $2,400 becomes the new default.”
“That’s devastating for long-term retirement security,” the person added.
David Gray, senior vice president of workplace retirement plan solutions at Fidelity, said if Congress decides to move in the direction of limiting pretax contributions, the cap should be $9,000 annually or more, rather than $2,400. He also said that Congress should “enhance and expand” the current saver’s credit that low- and middle-income households can take for making contributions to retirement plans.
“From our perspective, we are supportive of a pro-growth, pro-investor package, and we understand Congress may need to look at some pay-fors for that tax reform,” Gray said. “We believe that any tax-reform proposal that impacts retirement savings needs to maintain the policy goal of encouraging and enhancing savings.”
The financial industry broadly supports tax reform and is trying to talk with lawmakers about the potential consequences of curbing pretax retirement contributions. The Save Our Savings coalition is holding a fly-in with CEOs and other leaders on Nov. 1.
Besides industry groups, Republicans’ consideration of a cap on pretax retirement contributions has garnered pushback from Democratic lawmakers.
A Wall Street Journal article Friday on the potential cap prompted a quick response from Senate Minority Leader Charles Schumer (D-N.Y.).
“Republicans are so determined to cut taxes on the wealthy that they’re willing to tax the retirement accounts of millions of middle class Americans,” Schumer said in a statement. “The GOP’s total devotion to millionaires and billionaires comes at the expense of every family using a 401(k) to save for a decent retirement.”
Last month, following reports that “Rothification” was under discussion, Democrats on the Ways and Means Committee and Senate Finance Committee spoke out in letters to GOP congressional leaders and Trump administration officials.
House Majority Leader Kevin McCarthy (R-Calif.) in early September pushed back on the idea that Republicans want to tax 401(k)s.
“Why would you punish people when they’re actually saving for their own retirement and they’re not looking to government?” he said in an interview on the Fox Business Network. “You want to incentivize that even further. Don’t punish people who actually save their own money.”