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Could Congress Put 401(k)'s in the Crosshairs?

Posted by Brock Bowers on

According to the non-partisan Tax Policy Center, America's proposed tax reform plan would reduce federal revenues by $7.2 trillion over the first decade.


That money needs to come from somewhere, and your 401(k) plan may be in the crosshairs.


"First, they were safe. Then, it wasn’t so clear. Now, they’re back in. But they still might be out." -Fortune Magazine


401(k) accounts are a juicy target, with Trillions of dollars at stake. Congress may not be able to resist the temptation to change the rules.


Established in 1978, 401(k) accounts have provided taxpayers with an upfront tax deduction and a tax deferral until withdrawal. Taxpayers could reduce taxable income by up to $18,000 in 2016 with 401(k) contributions, and that money could then grow tax-free until withdrawn in retirement.


But according to the latest report from the Joint Committee on Taxation, excluding those contributions and earnings from taxation cost the federal government more than $90 billion in potential tax revenue in 2016. That number is expected to rise to $146 billion by 2020, and total almost $584 billion from 2016 to 2020.


With those kinds of numbers, no wonder Congress is taking a close look at 401(k) plans.


By treating 401(k) contributions like Roth contributions, the government could raise an estimated $1.5 trillion over the next decade. Taxpayers would no longer have the upfront income deduction, but earnings and appreciation would be tax-free going forward.


However, if the tax-deferred nature of 401(k) accounts is changed too, it becomes a much more expensive problem for taxpayers.  One proposal would impose a 15% tax on annual gains within 401(k) plans, producing between $48-60 billion dollars annually between 2018 and 2025.


After confusing signals, the administration says it does not – but lawmakers may have other plans.


On Wednesday April 26, 2017, US National Economic Director Gary Cohn and Treasury Secretary Steven Mnuchin unveiled the president's tax proposal. While saying that retirement savings would be protected, the exact scope of protection was not clear.


The next day, White House Press Secretary Sean Spicer said the tax plan would not affect charitable and mortgage deductions, but when specifically asked about tax treatment of 401(k)s , he said, “The current plan right now both protects charitable giving and mortgage interest and that's it."


The comment caused a stir, but the White House soon clarified that Spicer was referring to deductions and not exclusions from taxable income. This presumably includes the 401(k) income exclusion.


The wild card, then, could be lawmakers in Congress.


In order to pass tax reform and appear revenue-neutral at the same time, Congress will need to make significant changes and concessions. Unless otherwise persuaded, the loss of your 401(k) tax benefits could very well be one of those changes.


White House economic advisor and former Goldman Sachs president Gary Cohn made Americans feel the exact scope of the protection wasn’t clear, which led to speculation that tax deductions for 401(k) contributions could be reduced, or perhaps even eliminated altogether.


But despite the White House’s declaration that 401(k) contributions would be left alone, there is still the possibility that they could still be subject to modification, or even elimination.


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