Don’t be surprised if DC decides to find some much-needed revenue from retirement contribution deductions. It could change how Americans save for retirement.
A large part of the tax reform debate now underway, concerns overhauling the corporate tax code. However, attention is also turning to American’s retirement savings. That could have a huge impact on individuals, according to CNBC in “Tax reform could change the way you save for retirement.”
The Trump White House and Republicans say they want to streamline the tax system, by allowing Americans to file their returns using just a large postcard. To do that, they’re thinking of eliminating most of the individual deductions, except for mortgage interest and charitable donations. The White House then said that it would also preserve the deduction for 401(k) contributions. However, the Save our Savings Coalition is concerned that this could come with some large exceptions. Deductions for retirement contributions are worth $583.6 billion through 2020. That source could be hard for lawmakers to resist, as they look for ways to pay for tax cuts.
Individuals can now defer taxes on the money they save for retirement, until it’s withdrawn. That encourages households to save, since their tax rate is usually lower during retirement than when they’re working and saving.
However, there are proposals on Capitol Hill that would change when that money gets taxed. One plan permits half of the allowable retirement contributions to be taxed up front. However, households would be able to withdraw the money in retirement tax-free, like a Roth IRA.
Senator Jeff Flake, R-Ariz., and Representative Dave Brat, R-Va., introduced a bill that would create a new universal savings account in which consumers could contribute $5,500 after taxes. Unlike a retirement account, withdrawals could be made at any time tax-free with no penalties. This was included in the House blueprint for tax reform.
Another proposal that’s frequently discussed is capping the level of deferred contributions. The current limits are $18,000 a year for a 401(k) and $5,500 for an IRA (with annual adjustments for inflation). That’s been identified as a potential revenue raiser. This is critical because Republicans say that tax reform will be revenue neutral (any tax cuts will be paid for with revenue from somewhere else). The GOP plan would consolidate households into three tax brackets of 12, 25 and 33% in a move that would lower the top rate by 6.6%.
According to the Tax Policy Center, the decrease in personal rates alone could cost $2.6 trillion over the next ten years, and that’s not including the impact of economic growth. If policymakers are looking for revenue, says one former lawmaker, they are more than likely to train their sights on American retirement accounts. The money has to come from somewhere!
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