President Trump and Republicans are trying to make tax reform a priority, but few details have emerged at this point. Complicating the conversation is a desire to make any tax reform revenue neutral. There have been a few ideas on how Congress might accomplish that objective, but they involve many of the favored deductions. One in particular that has quietly bubbled up is the elimination of the tax-deductibility for 401(k) contributions. In a 2014 government analysis, it was estimated that the taxing of 401(k) contributions would generate roughly $144 billion during a 10-year period.
But, at what future cost? The taxing of contributions instead of distributions would likely lead to a significant reduction in the use of these investment vehicles. According to the Committee on Investment of Employee Benefit Assets (CIEBA), only about 10% of 401(k) participants utilize Roth accounts (after-tax funding of DC plans). We already have a retirement crisis unfolding in the U.S. as a result of the demise of the defined benefit plan, why exacerbate the situation?
Furthermore, the U.S. does eventually “capture” this tax revenue upon distributions from individual accounts, so any discussion about lost revenue is just not correct.
We know that it is highly unusual that individuals save for retirement outside employer sponsored programs. Do we really need a greater percentage of our workers left with little to nothing as they near retirement? Also, the tax revenue that will be lost as a result of financial companies managing far less retirement money will further contribute to the revenue shortfall likely to occur as a result of this action.
As we’ve highlighted many times, we don’t think that 401(k) plans are an appropriate replacement for the DB plan, but they are really the only game in town for the private workforce. Taxing the contributions into these plans instead of the distributions will basically be their demise. Then what?