Ask The Advisor: November 2017

Ask The Advisor: November 2017

Would Tax Reform Affect My IRA and 401(k)?

Q:  Can you tell me what sort of tax reforms have been proposed, and what might that mean for retirement accounts like IRAs and 401(k)s? Although I’m over 60, I’m still working and paying into a 401(k) account where I work. My husband and I are middle income.


A:  Unfortunately Social Security benefits are not the only retirement income at risk of cuts by Congress. There’s growing concern from retirement advisors that retirement accounts — such as 401(k)s, and traditional IRAs — could become a target of tax reform to pay for tax cuts. The changes under discussion would ultimately reduce the amount of money the accounts would provide to retirees.

Proposals to reform the tax code would do away with most deductions and so-called “tax shelters,” in order to provide reductions in individual and corporate tax rates as well as to eliminate the estate tax and alternative minimum tax (which affect higher income families.) Concern is growing that retirement accounts could be included because the Congressional Joint Committee on Taxation estimates that over the period ending in 2020, 401(k) plans and retirement plans will result in more than $580 billion in “lost” tax revenue to the federal government.

But this argument is just a smoke screen for Congressional lawmakers to make the math work on their tax legislation. The taxes on contributions to traditional IRAs and 401(k)s aren’t lost at all. Under current law, those taxes are only deferred until the money is withdrawn from the account. Contributions to 401(k)s and traditional IRAs are not taxed in the year that you earn the money, and but the year in which you withdraw it from your retirement account. Retirement accounts allow working middle and lower income people to pay lower taxes when their income is more likely to be higher, and pay taxes only on withdrawals when retired and less likely to have higher income based on earnings from work.

Among the tax reform proposals under discussion, working people would not be able to deduct contributions to 401(k)s or traditional IRAs from income. Instead, all income would be taxed in the year earned.  Contributions to 401(k) and traditional IRAs would be made after taxes, but withdrawals would be tax-free. This is how Roth retirement accounts currently work.

Retirement advisors believe changing retirement accounts to after tax dollars would severely impact most workers’ ability to save, and would reduce the amount of money that people have available to spend later. Steve Vernon, a research scholar for Stanford Center of Longevity who writes for CBS MoneyWatch, says that a typical middle-income worker could lose $500 per year if their 401(k) plan is “Rothified.” The bottom line would mean higher taxes while you continue to work, less money to put away in a retirement account and less to spend in retirement.

TSCL is closely watching this proposal. The proposal runs counter to encouraging workers to save for retirement and would erode retirement security for millions of middle-income working Americans who already struggle to save enough for retirement.

Source:  “How Tax Reform Could Sting Your Retirement Income,” Steve Vernon, CBS News, August 10, 2017.