Tax Cuts for the 1% Coming Out of Your 401K

If you have been in a 401K like I have over the decades, you know this has been helpful in reducing tax on your income. If you do not know this, you do now. The GOP is making eyes on your 401k contributions with the intent of removing the upfront deduction which lowers your taxable income. The GOP would like to go to a Roth type of 401k. Either way, I would be ok.

The problem I have with this idea is it is being presented as a way to help holders of a 401K today. It is not. The entire exercise here is provide enough offsetting revenue to provide a major tax cut for those making >$500,000 annually which number ~1.5 million households of the 154 million tax paying households. Why would the GOP want to do this? A tax cut would have to be passed through Reconciliation as Dems would filibuster to block it and that would require a super-majority vote (which was not the intent of the founders[that is a different story]). Reconciliation also requires no deficits be created at 10 years otherwise the act sunsets the same as the 2001/2003 tax breaks did in 2014(?).

I do not know who Prof. James Choi is; but, I do know who Andrew Biggs is as he would make appearances here to challenge Bruce Webb and Dale Coberly on Social Security. Those discussions were a great way to learn about Social Security. The points Bruce had made in support of Social Security can be found at Social Security Defender or by doing a search at Angry Bear. Andrew Biggs felt the need to privatize Social Security claiming it was bankrupt.

Both Andrew and (I assume) the Professor are in favor of the transition to Roth Accounts, taxing income before 401ks, and also in funding tax cuts for those making > $500,000. The rest of this article can be found here; The GOP is looking for ways to pay for tax cuts. Your 401(k) may bear the cost.

“Some others say removing the up-front payroll deduction on 401(k)s would not have a big effect on participation. Many savers in the plans don’t understand the differences in the tax consequences between the 401(k) and Roth-based accounts, according to one study.

James Choi, a professor of finance at the Yale School of Management who has done research on the subject:

‘The evidence suggests that there will be relatively little impact on 401(k) participation and contribution rates if we switched to a Roth-only system, in large part,’ Choi said, ‘people don’t understand how 401(k) taxation works.’

He cited one survey in which only 49 percent knew that making before-tax 401(k) contributions decreases taxable income in the year of the contribution. Only 46 percent responded that making Roth 401(k) contributions does not affect taxable income in the year of the contribution, Choi said.

One possible advantage of paying the tax up front is that you meet the obligation based on your current tax rate instead of owing based on a future rate that could be higher by the time you retire.

Andrew Biggs, a resident scholar at the American Enterprise Institute, a Washington-based think tank favoring free markets, said the biggest issue for 401(k)s is signing people up.

‘Some people may like paying upfront with the tax-free withdrawals, while others might like the tax savings today,” Biggs said. “But this isn’t as big a deal as something like automatically enrolling people in 401(k)s. That’s a major effect, while the tax treatment is more around the margins.’”

I would say an issue with 401ks is a lack of company contributions and a lack of company contributions without regard for employee contributions. It should also be a defined benefit plan and not a defined contribution plan with matching employer contribution. One other thing to consider if you have a stream of income to sustain yourself at 70-1/2 years of age. Consider rolling your 401K into a Roth to preserve the equity you gained from compounding; otherwise, you will lose much of it over the years in taxes.

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