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What will tax reform do to retirement plans?
May 24, 2017 at 9:43 AM

Two jars of money, one with dollar bills and one with coins. The one with coins has the word "tax" on it.Although the Trump administration has floated a general tax reform proposal, little detail has been provided. However, it is clear that additional revenue will be needed to fund the tax cuts the president proposed. Retirement plans are a likely target, as they were responsible for a reduction in federal revenues by $83 billion in 2016, according to the nonprofit Tax Policy Center.

The most likely target is 401(k) savings plans. One area of discussion is the so-called Rothification of retirement accounts such as 401(k), 403(b) and 457 plans. Such an approach would call for all or a portion of the contributions to these accounts to be made on a post-tax basis and eliminate the current deduction for such contributions. Under this proposal, the distributions from these accounts at retirement would not be subject to tax. However, for a taxpayer in a 25 percent bracket, it would take $24,000 of earnings to make the $18,000 maximum contribution to a 401(k) plan.

A second proposal is a freeze on retirement plan limitations for 10 years. Currently the individual limits are $18,000 for 401(k) contributions, $6,000 for catch-up contributions, and $54,000 for total contributions to a defined contribution retirement plan and are indexed annually. Other ideas from the past that could be resurrected include an acceleration of required minimum distributions for retirement plan participants and beneficiaries.

The proposed 15 percent maximum tax on pass-through income poses a different risk to small business retirement plans. Business owners will be faced with the dilemma of paying a 15 percent tax on this income currently or taking a deduction for a retirement plan contribution, only to pay tax at a 35 percent rate when the funds are withdrawn. If there is no advantage to deferring income in a retirement plan, it is doubtful that business owners will continue to sponsor retirement plans.

We have a long way to go before we see tax reform, and some pundits believe there is only a 50-50 chance that real tax reform will pass. If there is reform, there will be winners and losers. Hopefully retirement savings will not be among the losers.

Tags: 401(k)
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