As Republicans prepare for the release of their tax reform bill on Wednesday, asset managers and industry groups are warning that any cuts to the tax benefits of 401(k) accounts would depress the retirement savings rate, while tax experts caution that low-income American workers could incur tax disadvantages.
The retirement investment industry is concerned about talk that House Republicans are considering lowering the amount American workers can contribute to 401(k) plans with pretax income in a year to $2,400. Under current 401(k) programs, workers are not taxed on contributions up to $18,000 annually, but they get taxed on withdrawals.
House Ways and Means Committee Chairman Kevin Brady (R-Texas) told Fox News on Friday that his committee is considering increasing the limit on annual caps on contributions to 401(k) accounts to $20,000 a year or more, but did not specify whether the limit for tax-deferred contributions would be lowered.
Industry sources say that under some of the GOP proposals, workers whose contributions exceed $2,400 annually and who want to keep their money in a 401(k) would be required to put the excess funds into a Roth 401(k), where contributions come from post-tax income but withdrawals and gains aren’t taxed.
Shifting the tax revenue from the future to the immediate would boost government revenue over the next decade, during which the proposed tax measure will likely face a $1.5 trillion cost limit under budget rules approved by Congress earlier this month.
Asset managers such as Vanguard Group say limiting the amount of tax-deferred contributions to retirement accounts would end up lowering the public’s savings rate.
“The 401(k) plan is the cornerstone of the future retirement security of millions of Americans,” Vanguard spokeswoman Laura Edling said in an emailed statement on Friday. “Proposals that mandate contributions be made after tax should be carefully reviewed to take into account their impact on incentives to save.”
A spokeswoman for Brady did not comment on potential changes to 401(k) accounts, saying there’s nothing to add to Brady’s comments from last week on the topic.
Save Our Savings Coalition, whose members include the AARP, the National Association of Insurance and Financial Advisors, Financial Services Roundtable and T. Rowe Price, sides with the asset management industry in opposing a smaller pretax 401(k) contribution allowance.
Brigen Winters, a principal at Groom Law Group in Washington who’s lobbying on behalf of the Save Our Savings Coalition, said in a Friday interview that there’s concern that a number set forth by the government as low as $2,400 would falsely suggest that the amount is all people need to save each year.
The 401(k) programs are often touted by politicians and investment industry players as a tax benefit for the middle class, but the wealthy benefit from them, too. The Employee Benefit Research Institute on Oct. 23 published a report that shows workers from a variety of income levels could lose some upfront tax deductions they currently take for 401(k) contributions, but those making in excess of $50,000 a year are more likely to contribute more than $2,400 to their plans.
At the $10,000-to-$25,000 wage level, 38 percent of 401(k) contributors invested more than $2,400 in their plan each year, according to EBRI. That percentage drops for those making $25,000 to $50,000 annually, but it jumps to 60 percent for employees earning between $50,000 and $74,999, and then climbs to 76 percent for people earning $75,000 to $99,999. Among those who earn $100,000 or more, 87 percent contribute more than $2,400 a year.
William Birdthistle, a professor at the Illinois Institute of Technology’s Chicago-Kent College of Law whose research includes investment funds, said in a phone interview that asset managers are worried about the possible lowering of the 401(k) pretax contribution limit because any decrease in retirement savings means less money under management, which in turn leads to a drop in management fees.
As of June 30, there were $5.1 trillion in assets held in 401(k) plans, making up 19 percent of total U.S. retirement assets, according to the Investment Company Institute. That’s up from 2007, when the assets represented 17 percent of the investment market. In 2015, about 54 million American workers contributed to a 401(k) plan, the institute said.
The question is not whether Americans will contribute less to Roth 401(k) plans than to traditional 401(k) plans. The question is whether the after-tax value of Americans' contributions to Roth 401(k) plans will be less than the after-tax value of their contributions to traditional plans.
Daniel Hemel, a professor at the University of Chicago Law School
“The question is not whether Americans will contribute less to Roth 401(k) plans than to traditional 401(k) plans,” said Daniel Hemel, a professor at the University of Chicago Law School. “The question is whether the after-tax value of Americans’ contributions to Roth 401(k) plans will be less than the after-tax value of their contributions to traditional plans.”
The problem with attempting such an evaluation, he said in an email Monday, is that “we would have to know what tax rates would be in the future if people stayed in traditionals.”
A shift toward Roth-style accounts shouldn’t hypothetically matter in the long term, assuming marginal tax rates stay the same, according to Hemel.
Birdthistle said politicians who would market a shift toward Roth-style plans as having a neutral effect on savers underestimate rate changes and the “architectural default” of transitioning millions of people to new kinds of plans. He also said analyses that show a neutral effect from “Rothification” are generally based on groups who voluntarily participate in Roth-style plans — that is, savers counting on climbing into higher tax brackets who have already calculated their costs and realized they would benefit by taking tax losses earlier in their careers, while they remain in the lower tax brackets.
Birdthistle said he would not have expected lawmakers to touch retirement policies a couple years ago, but now would not be surprised to see changes included in the tax bill as lawmakers look for more ways to maneuver the narrow budget they’ve allowed.
“They’re going to need things to offset all of the goodies, and the temptation is just enormous to use something like this,” Birdthistle said. “When push comes to shove, my sense is that they’ll basically dare people to get upset.”