Congress: No, We Totally Might Mess With Your 401(k) In This Tax Plan

Image courtesy of Mike Silva

Even though President Trump recently promised that your 401(k) retirement accounts would not be negatively affected by the ongoing effort to cut taxes, the folks in Congress who are actually deciding what tax laws will be changed say that putting limits on retirement plans is still a distinct possibility.

Who Said What?

Last week, the Capitol Hill rumor mill churned up the idea that in order to make the numbers behind a massive tax overhaul package work out, Republican leadership in Congress might consider a drastic cut to Americans’ 401(k) retirement plans — specifically, that the tax reforms could put a lower limit on the maximum amount you’re allowed to contribute to your 401(k).

These rumors sparked immediate backlash, which President Trump attempted to quell via — what else? — Twitter, claiming that the Republican tax plan would include “NO change” to the “great and popular” 401(k).

Some members of Congress, however, appear not to feel particularly beholden to what the President promises.

Rep. Kevin Brady (TX) is the chair of the House Ways and Means Committee, the committee that’s handling the tax proposal. The tax bill is, basically, his as much as it belongs to any individual member of Congress, and he said at an event today that changes to 401(k) plans are indeed still totally on the table.

“We think we can do better,” Brady told attendees.

However, as the Washington Post notes, that “better” was incredibly light on details, with Brady saying only, “we are continuing discussions with the President, all focused on saving more and saving sooner.”

Update: In a press conference that took place right after this story was published, President Trump said that it was possible that changes to 401(k) accounts would end up as part of the tax plan.

According to Reuters, Trump told reporters, “Maybe we’ll use it as negotiating but trust me … there are certain kinds of deals you don’t want to negotiate with.”

The Big Idea

The Republican majority’s plan is to lower tax rates. The modern-day party’s core philosophy holds that less taxation is better for the overall economy, and so that’s the agenda they came into power with and plan to enact.

But the revenue that the federal government generates from taxation doesn’t just sit around in a giant Scrooge McDuck tower; it gets used to fund agencies, programs, and services. Lowering tax rates means that you have less money coming in, which means you need to figure something out about all that spending.

The White House has long since proposed steep spending cuts to offset tax cuts — but that only gets the feds partway there.

That brings us to the 401(k). These retirement plans are tax-deferred, meaning that whatever you contribute to them while you’re working doesn’t count as “income” for the purposes of calculating your income tax. If you earn $50,000 this year, but contribute $5,000 to a 401(k), then as far as the IRS is concerned your taxable income is actually only $45,000.

Currently, individuals under 50 can contribute a maximum of $18,000 annually to a 401(k), and individuals over 50 can contribute $24,000 per year to theirs. That’s a pretty significant chunk of pre-tax income, if you’re anything near the max.

The proposed new cap on contributions, though, may be as low as $2,400 — a mere $200 a month. If that’s the case, then you could suddenly have up to $16,000 of additional taxable income showing up in your paycheck.

That’s what makes the math behind a tax cut work out, then: Your rate may be lowered, but the amount of income you have that’s considered taxable goes up. And so in the end it can be basically a wash for the government: the principle at play is that 5% of $100 is the same as 10% of $50, and either way the feds get $5.

The Pushback

The idea of slashing the cap on Americans’ primary retirement savings plans to less than one-seventh of their current levels does not sit well with many.

The average American has nowhere near enough money saved for retirement, and roughly a third of us have nothing at all socked away for our golden years. The trend, therefore, has been to encourage Americans to save more where possible.

It’s hard to be specific, because the math has a ton of variables in it, but by and large experts estimate that most folks will need six or seven figures in the bank to retire comfortably. But if you can only put $2,400 per year into your 401(k), that’s only $96,000 after 40 years of contributions. Even employer matches and market growth can only do so much with that.

It’s not just individuals who are displeased with the idea, though. There’s massive money in the money business, and the banks and investment firms that manage retirement accounts (and their trade groups) have concerns about the idea that less money would funnel to them. If fewer people are investing money in accounts, and the ones who still are invest less, that’s bad news for the companies that make their profit from the funds.

Support for slashing the 401(k) isn’t exactly universal in Congress, either. Back when the rumor about the proposal first hit, Ohio Senator Rob Portman told the WSJ that he was “skeptical” about the proposal, adding, “I don’t think you want to disincentivize retirement savings in any way right now.”