Tax Reform and Your Business 401(k)

House Ways and Means Committee Chairman Kevin Brady (R – Texas) is expected to release a draft of tax reform legislation on Wednesday—and it may have major effects on your company’s retirement plan, along with worker incentives to save.

“We think in tax reform we can create incentives for people to save more and save sooner,” said Brady at a breakfast gathering last week, who also stated that many people with access to a 401(k) contribute $200 per month or less. (Many financial professionals recommend saving 10% to 15% of pay, which may be more or less than $200 per month for some workers.) “We think we can do better. We are continuing discussions with the president, all focused on saving more and saving sooner.”1

The current 401(k) contribution rates are $18,000 for those under the age of 50, and $24,000 for those over 50 (often referred to as catch-up contributions). Those are set to increase to $18,500 and $24,500, respectively, in 2018. Congressional Republicans are discussing proposals that would potentially cap contributions at $2,400 per year.2

Meanwhile, Democrats released a competing proposal today: An increase in 401(k) contribution limits to $24,500 for those under the age of 50, and $30,500 for those over the age of 50.3 The Tax Policy Center, a non-partisan Washington think tank, projected an average annual tax savings of $67.2 billion for those who contribute to defined-contribution 401(k) accounts. Under tax reform with a cap on defined-contribution 401(k) accounts, Congress would be looking to gain more of that tax-deferred money up front to help pay for income rate cuts.

If tax reform is passed, it could change the way businesses currently run and offer their retirement plans. Tax reform that lowers contribution limits could mean that more business owners shift away from traditional 401(k) plans to more Roth 401(k) plans, which allow workers to invest after-tax dollars rather than pre-tax dollars. Roth accounts are popular with employees who are in lower tax brackets, because their income is taxed at a lower rate than it might potentially be later on in life (due perhaps to a pay raise or promotion), or during retirement.

However, workers in higher tax brackets who want more of their money to grow tax-free may prefer a traditional 401(k) because their income is not taxed up-front, meaning workers can contribute more without being taxed as highly.

Last week, President Trump announced on Twitter that there should be no changes to current 401(k) tax benefits, and after Brady’s comments, reiterated his commitment to keeping 401(k) deductions in place.

 

1 Brady’s quotes were sourced from a Washington Post article. https://www.washingtonpost.com/news/business/wp/2017/10/25/house-gop-tax-leader-threatens-to-break-trumps-promise-not-to-change-401k-rules/?utm_term=.8957b4f81e2e

2 Information about Republican proposals was sourced from a New York Times article. https://www.nytimes.com/2017/10/23/us/politics/trump-401-k-tax-budget.html

3 http://www.washingtonexaminer.com/democrats-pitch-plan-to-raise-pre-tax-limit-on-401k-savings/article/2639104

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