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Tax reform could change the way you save for retirement

  • Deductions on retirement contributions are worth $583.6 billion through 2020, a piggy bank that could be hard for lawmakers to resist.
  • Some of the proposals being floated on Capitol Hill would change when retirement savings get taxed or alter the amount of annual contributions.
  • Republican leadership has vowed that tax reform will be revenue neutral.

The fight over tax reform is starting to get personal.

So far, much of the debate in Washington has centered on overhauling the corporate tax code. But a new coalition of consumer and industry groups is spotlighting the potential for major changes to the individual side — particularly the way that Americans save for retirement.

The White House and Republican leadership on Capitol Hill have said they want to streamline the tax system, allowing Americans to file their returns using nothing more than a large postcard. To achieve that, they are considering eliminating most of the individual deductions in the tax code. The principles for reform the administration outlined in April save only two: for mortgage interest and charitable donations.

Later, the White House clarified that it would also preserve the deduction for 401(k) contributions. But the Save our Savings Coalition — whose members include AARP, Fidelity and TIAA — is worried that promise could come with some big caveats. Deductions for retirement contributions are worth $583.6 billion through 2020 — a piggy bank that could be hard for lawmakers to resist as they scrounge for ways to pay for tax cuts.

"You get the sugar high if you tax retirement plans right now for tax reform," said Diann Howland, vice president of legislative affairs at the American Benefits Council, a member of the coalition. "But it's going to have a drain on the federal Treasury in the out years because you won't be getting that revenue back in."

Under the current system, individuals can defer taxes on the money they save for retirement until it is actually withdrawn. That benefit encourages households to save, Howland said, since their tax rate is usually lower during the golden years than while they are working and saving.

Senior couple retirement
Stephanie Hager | HagerPhoto | Getty Images

But some of the proposals being floated on Capitol Hill would change when that money gets taxed. Under a plan drafted in 2014 by the former Rep. Dave Camp, who served as chairman of the House Ways and Means Committee, half of allowable retirement contributions would have to be taxed up front. However, households would be able to withdraw the money in retirement tax-free, similar to the way Roth accounts are structured.

More recently, Sen. Jeff Flake, R-Ariz., and Rep. Dave Brat, R-Va., introduced legislation that would create a new universal savings account. Consumers would be able to contribute $5,500 after tax, and unlike in a retirement account, withdrawals could be made at any time tax-free with no penalties. The idea was included in the House blueprint for tax reform.

Supporters argue the accounts would supplement retirement savings, but advocates worry they could eventually become a replacement as lawmakers seek to streamline the system. A spokeswoman for the Ways and Means Committee said it remains committed to 401(k)s, though she left the door open for changes to their structure.

"401(k)s are a critical savings tool for workers, and we are looking to grow more savings in America," she said. "We're considering solutions that increase the number of people using 401(k)s and other savings vehicles."

Another proposal that resurfaces frequently is capping the level of deferred contributions. Right now, the limits are $18,000 a year for a 401(k) and $5,500 for an IRA, and they're adjusted annually for inflation. The Congressional Budget Office has identified changing those amounts as a potential revenue raiser.

That's important because Republican leadership has vowed that tax reform will be revenue neutral — in other words, any tax cuts will be paid for with revenue from somewhere else. The GOP plan would consolidate households into three tax brackets of 12, 25 and 33 percent — a move that would lower the top rate by 6.6 percentage points.

The Tax Policy Center estimates that the reduction in personal rates alone would cost $2.6 trillion over the next decade without factoring in the impact of economic growth.

"The retirement security pot of money is pretty big in the United States," said Jim McCrery, a former congressman from Louisiana who is working with Save Our Savings. "So if policymakers are looking for revenue to do a revenue-neutral tax bill, it's a logical place for them to look."