Update: the final signed version of the bill left 401K contributions unchanged, so this is no longer a concern. However, maxing out your 401K can still be a smart strategy.
If you haven’t been paying close attention, you may have missed the recent news that 401K tax deductions are possibly on the chopping block as part of the Trump/Republican tax cut plan – a plan that would give 80% of the tax cut value to the top 1% of income earners.
The maximum 401K contribution deduction is currently set at $18,000 for 2017 and $18,500 for 2018. According to reports, the deductible amount could be cut as low as $2,400 per individual.
What kind of an impact would this have?
An individual making $60,000 per year (25% tax bracket) that wanted to max out his/her 401K would see a $3,900 tax increase (a drop to $600 in tax benefits instead of $4,500 under the current limits), for example.
While it is true that higher income earners disproportionately benefit from 401K tax savings, the true casualties of this plan would be responsible middle class individuals. With defined benefit pension plans virtually being extinct, 401K’s are the last great hope for any middle class individual to afford his/her own retirement.
Aside from the tax increase, something that isn’t being mentioned in the media is the detrimental impact this policy could have on 401K matching funds. Many employers offer a 401K match based off of employer contributions or as a percentage of the maximum IRS allowed contribution. If individuals could only deduct $2,400, you’d rarely see contributions go over this amount and many employers may adjust their matches downward to be in line with the new maximums.
In my case, my employer matches 50% up to the maximum contribution, which would equate to $9,000 in 2017. At a $2,400 max contribution, that would drop to $1,200, meaning I would take a $7,800 hit with this policy (over $11K if you factor in the tax increase). The net effect of this policy would be a death spiral for 401K matching.
The only reason the 401K deduction is on the table at all is because Republicans are hoping to stay deficit neutral in funding their tax cuts through the budget reconciliation process (a procedure that would only need 51 votes instead of the typical 60 votes needed to pass). At best, this is extremely short-sighted. A 401K deduction cut may increase short-term revenues, but it would dramatically decrease long-term revenues (robbing the future to pay the present), as traditional 401K’s are taxed at the time of withdrawal. It also would increase reliance on government entitlements and assistance like Social Security, Medicare, Medicaid, and food stamps in the long-term, as the ability to fund one’s own retirement would be limited. But hey, why should we let the future of the country get in the way of a rich donor tax cut?
If you don’t like this policy (you shouldn’t), there are 2 immediate actions you can take:
- You’ve got 2 months left in the year. If you weren’t planning to max out your 401K contributions this year, I’d strongly encourage you to do so (if you have the cash flow to make that happen). It would take you 7.5 years of $2,400/year contributions to equal this year’s $18,000 in contributions. In other words, get it while you can.
- Call your members of Congress to tell them you do not support the 401K deduction cut (or any plan that would increase taxes on the middle class) and you will hold them accountable for their vote. You can reach your Congressional (House and Senate) members by calling (202) 224-3121. You can find your House member here and Senate member here.