Republicans in Congress are planning to include a proposal in their tax reform bill that would push millions of Americans to save less for retirement. Despite President Trump tweeting his strong and unambiguous opposition to the plan on Monday, House Ways & Means Committee Chairman Kevin Brady made clear on Wednesday that the proposal that makes changes to 401(k) retirement savings plans is still likely to be included in the House Republicans' tax legislation scheduled for committee consideration next week.
This proposal is not really about retirement policy. Rather, it is one of several efforts by Republican lawmakers to make up for the federal revenues that will be lost when they slash corporate tax rates and give massive tax cuts to the highest-income Americans. In essence, it would raise taxes on middle-class retirement savers to fund tax cuts for the wealthy.
America is already in a retirement savings crisis. This proposal would exacerbate the crisis. The vast majority of today's American households will not have enough retirement income to maintain their pre-retirement standard of living. Fewer than a quarter of baby boomers-those reaching retirement age right now-think they will have enough retirement savings to last the rest of their lives.
Simply stated, many Americans-perhaps most Americans-are on a path to outlive their money in retirement. They need to save more for retirement, and grow those savings. The Republican tax proposal would encourage them to save less. Here's how it would work.
Under existing law, working people can contribute up to $18,000 to a 401(k) account (an employer-provided retirement plan) without that money being subject to federal income tax until it is withdrawn. The Republican proposal will dramatically reduce the cap on tax-free contributions by 87 percent to only $2,400.
According to a new analysis by the Employee Benefit Research Institute, workers contributing to their 401(k) accounts with earnings at every income level above $10,000, and in every age group from 25 to 64, contribute more than $2,400, on average. Participants of all types with 401(k) plans will be affected by the Republican proposal.
If Congress takes away almost all of the tax incentive to save for retirement, Americans will save less. Evidence comes from Americans considering individual retirement accounts (IRAs) who already have the option of selecting the type of arrangement Congress is now considering. Under existing law, individual retirement savers can choose either a traditional IRA, with tax-protected contributions and taxed withdrawals, or a Roth IRA, with taxed contributions and tax-protected withdrawals.
They have made a clear choice. Americans owned $7.9 trillion in IRAs at year-end 2016, with Roth IRAs constituting only $660 billion of that total. That's fewer than one in 12 IRA dollars invested in the tax-first-ask-questions-later option Congress is now talking about applying to 401(k)s. Retirement savers do not want their contributions eroded by taxes.
Let's say a 50-year-old worker wants to retire at age 65. She realizes she hasn't saved enough for retirement, so she puts $18,000 tax-free in her employer's 401(k) in 2018. Fifteen years later, if she gets an average return of 7 percent in the stock market, her retirement savings will grow to about $49,663 before taxes. After taxes are taken out, if the worker is in the 25 percent tax bracket, $37,247 will be left.
But if the Republican proposal becomes law, that same 50-year-old will likely save only $2,400 in her employer's 401(k)-the amount that won't be subject to federal income tax. Fifteen years later, following the same investment strategy, her retirement savings will grow only to about $6,622 with no taxes deducted.
This illustrates the consequences for just one year's retirement savings decision: $37,247 vs. $6,622. If the Republican proposal is enacted and survives for 10 years, multiply those very bad results.
Most Americans face a difficult choice every time their paychecks show up in their mailboxes or their bank accounts. Where should those dollars go? Should they spend them on the mortgage, bills, clothes, or food, or perhaps save for a kid's college years, or should they put them in a retirement account? Drastically reducing the existing tax incentive makes it harder for ordinary Americans to choose their retirement accounts over other pressing and immediate needs.
A smart retirement policy designed to strengthen the middle class would make it easier for Americans to save for retirement at work, incentivize them to save more, help them to grow their savings significantly over time, and provide more access to products and strategies that provide a guaranteed income --- a regular and reliable "retirement paycheck" --- for the rest of their lives.
Effective solutions to the retirement crisis are possible, but the Republican 401(k) tax proposal definitely isn't one of them.
Commentary by Seth D. Harris, the former Acting Secretary and Deputy Secretary of Labor in the Obama Administration. He is an attorney in Washington, D.C. and a Visiting Professor at Cornell University's Institute of Public Affairs.
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