As Republicans on Capitol Hill begin the heavy lifting of reforming the country’s corporate and individual tax codes, lawmakers are forming proposals that would dramatically impact the tax-preferential treatment of 401(k) plans.
One idea being floated would treat all 401(k) deferrals as after-tax contributions, as Roth 401(k) deferrals are now treated.
That would create a seismic change to the country’s employer-based retirement system, and poses potential unintended consequences that industry insiders fear will disincentivize employers from offering defined contribution retirement savings plans.
“This idea would be devastating for our retirement system,” said Will Hansen, senior vice president for retirement policy at the ERIC Industry Committee, which advocates on behalf of large sponsors of retirement and health plans.
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In a recent interview on Fox Business, President Donald Trump walked back a soft deadline for finalizing tax reform legislation by August, a timeline publicly suggested last month by Treasury Secretary Stephen Mnuchin.
Nonetheless, Hansen said ERIC is treating the proposal to shift to an all-Roth system as more than beltway speculation. The trade organization is not waiting for a formalized proposal to push back against the idea. “It’s never too early to draw your line in the sand on what you believe is the best policy for our retirement system,” he said.
On the campaign trail, President Trump pledged to reduce the number of individual federal income tax brackets from seven, which now range from 10% to 39.6%, to three brackets—10, 20 and 25%.
He also proposed cutting the corporate tax rate from 35% to 15%. The House Republican blueprint for tax reform, also released last year, set the goal of slashing the corporate rate to 20%.
Estimates of Trump’s proposal range around $12 trillion over a 10-year period. In order to pass tax reform through budget reconciliation, those costs will have to be offset in part by eliminating current deductions in the tax code.
“Republicans are going to need revenue to pay for those cuts,” said Hansen, echoing a reality other industry advocates have been warning against since Trump’s election. “The clues are out there. If tax reform moves forward there will be some treatment to how retirement plans are taxed.”
The latest figures from the Joint Committee on Taxation show the tax-exempted status of defined contribution plans will result in $583.6 billion in forgone revenue between 2016 and 2020. Exemptions on traditional IRA contributions will cost $85.8 billion.
That Republicans passed on capping the exemption for employer-provided health benefits in the American Health Care Act makes new taxes on 401(k) deferrals all the more likely, says Hansen.
Republican leaders have given other indications that the tax incentives for retirement plans are a likely source for revenue offsets.