4 Ways Senate Tax Bill Hurts Retirement Plans

Capping an important benefit for the highest earners sets a dangerous precedent, says ARA's Brian Graff

While Rothification of 401(k) plans was not part of the Senate tax overhaul bill released late Thursday, the bill does include several negative provisions for retirement savers.

The most detrimental change places a cap on catch-up contributions for high earners, according to Brian Graff, CEO of the American Retirement Association, a trade group for retirement plan and pension professionals.

The extra contributions would be prohibited for workers making more than $500,000, but Graff worries that the cap could be lowered.

“Capping the ability to make catch-up contributions undermines the incentives of business owners to adopt and support retirement plans,” Graff said. “It’s a dangerous precedent — after all, what’s to stop lawmakers to decide to impose a limit of $250,000 or $125,000?” 

Graff points to the four provisions he finds worrisome in the Senate tax bill, the Tax Cuts and Jobs Act:

  • prohibits catch-up contributions for people making more than $500,000;
  • eliminates the special catch-up rules for 403(b) and governmental 457 plans and coordinating limits between 403(b) and 401(k) plans and governmental 457 plans;
  • applies the 10% early withdrawal tax to governmental 457 plans; and
  • includes the same provision dramatically limiting nonqualified deferred compensation that was part of the House bill but taken out of it on Thursday.

As ARA explains, "as of plan years and taxable years beginning after Dec. 31, 2017, individuals could not make any catch-up contributions – even on an after-tax basis – for a year if they received wages of $500,000 or more in the preceding year."

The House Ways and Means Committee passed its bill on Thursday. Senate Finance Committee Chairman Orrin Hatch, R-Utah, said his committee will begin marking up its proposal on Monday.

The House and Senate tax plans differ on several fronts. Here’s a breakdown:

Individual Income Tax Rate and Brackets

The House bill consolidates the current seven income tax rates into four, while retaining the top marginal rate of 39.6% and including an income recapture provision that phases out of the effect of the 12% bracket for high-income earners, sometimes called a “bubble rate,” according to the Tax Foundation.

The Senate bill retains the seven brackets while reducing rates, and lowers the top marginal bracket to 38.5%.

Estate Tax

The House bill increases the exemption to $10 million, indexed for inflation, with a repeal in six years. The Senate would increase the exemption to $11.2 million, with no proposed elimination of the tax.

Before being amended, the House bill would have increased the estate tax exemption to $10 million and indexed it to inflation, and then eliminated it after 2023 (starting in 2024), explains a Tax Foundation spokesman. The manager’s amendment the Ways and Means Committee adopted during the bill’s markup “would increase the exemption to $10 million, but it would not eliminate the tax until after 2024 (so starting with 2025).”

Alternative Minimum Tax

Both the House and Senate bill would do away with the AMT.

Corporate Tax Rate

Both bills cut the rate to 20%, but the rate would take hold in tax year 2018 under the House bill and in 2019 under the Senate’s plan.

Itemized Deductions

State and local property tax deductions are retained in the House bill but capped at $10,000, with the remainder of the state and local tax deduction being eliminated. The House bill also limits the mortgage interest deduction to the first $500,000 in principal value; the Senate eliminates the state and local tax deduction and sets the mortgage deduction at up to $1 million.

Treatment of Pass-Through Income

The rate is capped at 25% under the House bill while the Senate version adopts a 17.4% deduction for pass-through income. 

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