Trick or treat! It appears that Congress is in the Halloween spirit as they are poised to treat some taxpayers by tricking retirement savers. The GOP is focused on tax reform that supposedly will simplify the tax code for many Americans. The plans being proposed will incent big companies to pay more taxes by lowering the tax rate on foreign made profits. Ostensibly, the economy will then be juiced when those companies pay out those profits to shareowners or invest in capital projects.
For months, speculation centered on deductions for state and local taxes being reduced or eliminated to offset the reduced tax revenue expected from the corporate tax rate reduction. This made some sense, at least politically, as the states that have the highest tax burdens are predominantly Democrat leaning states. Then suddenly, this week the talk turned to 401(k)s.
Some GOP House members have been considering a cut in the current $18,000 401(k) contribution limit that would lower the maximum contribution to $2,400 a year. Perhaps this was even too scary for the Great Trumpkin himself, as he tweeted on Wednesday:
There will be NO change to your 401(k). This has always been a great and popular middle class tax break that works, and it stays!— Donald J. Trump (@realDonaldTrump) October 23, 2017
Maybe it's the season, but every time I hear a politician talk about how much this reform will help the middle class, I'm reminded of another president's words...
President Ronald Reagan
I will be the first to admit that I am somewhat biased against anything that discourages personal savings and investment. I also understand and appreciate the Laffer Curve, but what the GOP is currently doing is shifting the tax burden, not lowering it. Remember also that no one is discussing actually reducing spending, which is $440 billion more than tax revenues for fiscal year 2018[i].
While the details have yet to be worked out, the pre-tax incentives for savings will reportedly be replaced with the promise of tax free growth, similar to how Roth IRAs work today. Mathematically, it shouldn't make a difference when you pay your taxes, except that most folks are in higher tax brackets during their working years than when retired. When you also consider that there is talk of eliminating the estate tax (currently levied only on estates greater that $11 million), and that current rules allow non-spouse beneficiaries to delay paying taxes on inherited retirement accounts for decades, it's hard to believe that this "reform" is intended for those that need it most.
Options for Retirement Savers
The good news for now is that the candy buckets aren't empty yet. To help you get your fair share, I’ve summarized some popular defined contribution retirement options below. Most of these are well known, but some may offer treats you didn’t realize you were missing.
The 401(k) is the account being most talked about this week. For 2017, participants can contribute up to 100% of their pay to a maximum of $18,000 (plus $6,000 catch-up contributions for ages 50+). Employers can contribute up to 25% of an employee’s pay, with the maximum contribution combining the participant and employer of $54,000 (plus another $6,000 for 50+). The main drawback for small businesses can be the costs of implementation and complying with government regulations associated with the plans. Business owners with no employees other than a spouse, however, have the Solo 401(k) available. These allow for all the same tax benefits, but without the complexity or expenses of larger plans.
Maximum treat = $24,000 of pre-tax savings (for Solo 401(k) business owners, up to $60,000)
403(b) plans are very similar to 401(k)s, except they are offered through public schools and employees of certain tax-exempt organizations. For 2017, participants can contribute up to 100% of their pay to a maximum of $18,000 (plus $6,000 catch-up contributions for ages 50+). There is an additional provision for long term employees that haven’t contributed much or anything in the past. It is known as the 15 Years of Service Catch-up, and it allows up to an additional $3,000 to be contributed annually until a maximum additional contribution of $15,000 is reached.
Maximum treat = $27,000 of pre-tax savings
457 plans are like other defined contribution plans but are available to employees of certain state and local governments and even some non-governmental entities. For 2017, maximum deferral is up to 100% of pay to a maximum of $18,000. There is also the familiar age 50+ Catch-up of $6,000, BUT there is also Special Catch-up available to employees within three years of their “normal retirement age” (usually 62 or later, but check with your employer to confirm). Instead of $6,000, those employees can contribute an additional $18,000 per year.
But wait, there is more! 457(b) plans do not affect the total amount a participant can defer into other defined contributions plans. At institutions that offer both plan types (i.e. University of Texas), a participant can participate in both.
Maximum treat = $36,000 of pre-tax savings (if combined with a 403(b), $63,000!)
SIMPLE IRAs are less expensive and less complicated retirement plans available to small business that allow for employee contributions up to $12,500 in 2017 with a $3,000 age 50+ Catch-up provision. Employers are obligated to match contributions between 1-3%.
Maximum treat = $15,500 of pre-tax savings + match
Of course, IRAs are also available for contributions up to $5,500 with a $1,000 age 50+ Catch-up. These contributions can be made if you have earned income exceeding the amount to be contributed. There are both Traditional IRA (possibly tax-deductible contributions, tax-deferred growth) and Roth IRA (post-tax contribution, tax-free growth) account types to consider. What type makes the most sense can vary based on eligibility for other retirement plans and your income level.
A popular strategy for many is the “Back Door” Roth IRA, which is a method for essentially contributing to a Roth IRA even when you exceed the income eligibility levels (for 2017 it is MAGI of $133,000 for single filers and $196,000 for married filing jointly). However, there are some pitfalls to avoid paying unexpected taxes. That, however, is an article for another day.
In the meantime, if you're inclined to call your congressman or senator to express your thoughts, you better hurry. The ghouls are already negotiating this deal in the dark smoky back rooms on Capitol Hill. If you would like to discuss avoiding their tricks, or just getting your fair share of treats, get in touch.