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.
These “free market” wet dreams of funding retirement are only viable AFTER people have paid for food, shelter, health and taxes.
Health requires some down time from the task of providing for food, shelter and taxes.
So, 401K was just another way to shift the labor cost off the company. Though it did a nice job providing a steady revenue stream into the financial world that they could then play with and take all sorts of risks (still).
“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.”
What proportion of working stiffs like us will have a higher income tax rate after retirement than before? My income dropped to 40% of my income before retirement. My 401k’s began kicking in at 70.5 years with an income tax rate 1/4 of what it was before I retired.
If 401k’s are taxed as income before contributing to them the primary incentive to save dries up. Funds flowing into the market drop, driving demand for investment capital higher, which increase nominal interest rates… therefore also mortgage rates, automobile rates, home equity borrowing rates, etc.
The proposal to tax 401k contributions before withdrawal is simply a way to increase revenues now on the same gross income … otherwise known as just your everyday tax increase for those who can contribute to a 401k. .
Ya gotta love the conservatives for their chutzpah though. First we get rid of defined benefits plans provided by employers at employers’ risks,, transferring the burden to the employee as employees’ risk, and now tax the plan before it’s in the plan at full income tax rates.
That’s called a coup. Oh and while we’re at it Let’s reduce SS benefits or charge more for them to boot. .
The beneficiaries of this massive transfer to the shoulders of the 90% go to the upper 1% or 2% and a Wall.
Tale about labor being the patsies. And we sit back and take it bending over. Wow. I never thought I’d see the day that 90% of the public get’s it in the ass by their representative’s in gov’t shoving it in ’em.
Can you expound on this, please:
It should also be a defined benefit plan and not a defined contribution plan with matching employer contribution.
no one answered your request to expound
so you have to put up with me.
as I understand it “defined benefit” is no longer a viable option for even very large businesses.
my own understanding of the stock market (very limited) makes me doubt that most people can even equal the returns from SS by “investing” in the market. certainly the market is not the place to INSURE they will be able to retire, let alone provide for their family if they die or become disabled.
on the other hand SS is not really enough to provide a comfortable…. in the style you have become accustomed to… retirement. and it is unreasonable to ask “the rich” to pay for “the poor’s” retirements.
the answer would be, if the left was not as greedy as the right, to raise the SS tax more than the dollar a week it would take to solve the current actuarial “deficit,” but with the workers paying for it themselves. it will be more expensive for them that it has been in the past, but when they get old they will see it as the best bargain they ever made.
it is perverse that now that “we” are rich enough for most people to be able to afford to retire at a reasonable age at a reasonable level of comfort, we have become too stupid to understand that you have to actually put aside enough money for this to happen, even with the government gurarantee.
Jed knows what defined benefit is.
i know Jed knows what a defined benefit is. He asked for someone to expound on “it should be a defined benefit and not a defined contribution”
so I expounded on that.
and a note to joel (?) i used the quotes to suggest a paraphrase, not to claim a word for word quote, so please don’t accuse me of lying.
For the 401K or IRA holder, the choice of paying tax now or later makes little difference – no difference if the tax rates are the same. The Roth does essentially allow a larger maximum contribution since it’s after-tax money, but few invest that much.
The reason for a change of course, is to allow a tax cut NOW by moving taxable income to now from the future. A one-shot deal that will have to be paid for later.
Welcome to AB Tom. First time comment is sent to moderation first.
I agree mostly; but . . .
If in combination with Social Security, a 401k withdrawal taxed in the future is a lot less than now. If you are in the 1% of household taxpayers making >$500,000 that tax break which would not sunset if the tax revenues are there at 10 years. Tax breaks now are also worth far more for the 1%.
Why should most of the household taxpayers fund the 1% of the taxpayers especially when those taxes could be used mostly for their benefit?