President Biden’s Financial Plan and Your 401(k)

President Biden’s Financial Plan and Your 401(k)

Among the numerous changes to individual taxes that President Biden is proposing to pass into law in the first months of his term are some changes to the 401(k) plan that could significantly change retirement financial planning. According to reports, the most important changes will include:

• The current 401(k) tax deduction will disappear.
• Deductions will be replaced by a tax credit for all 401(k) contributions.
• The tax advantage of 401(k) contributions would be reduced for high-income earners and increased for low- and middle-income earners.

Current tax laws provide the most impactful tax breaks to people with the highest incomes, as broken down in a pre-election article in Forbes magazine:

As it stands, a raft of tax deductions incentivize Americans to contribute money to their employer-sponsored retirement plans. Let’s say you’re in the 24% marginal tax bracket and save $5,000 annually in your company’s 401(k) plan. That money goes into your 401(k) account before income taxes are assessed, saving you around $1,200 a year in taxes.

This incentive structure gives high earners a bigger tax break. Someone in the 37% bracket saves more tax dollars than someone in the 12% bracket. That same $5,000 401(k) contribution saves $1850 in federal income tax for someone in the 37% bracket, but just $600 for someone in the 12% bracket.

The Biden proposal will equalize the tax benefits at 26 percent across the income range: $260 for a $1000 contribution. Analysts state that the change is projected to be revenue-neutral from the government’s perspective (a good thing for politicians) and, as Eric Toder, co-director of the Tax Policy Center notes, will “help lower- and middle-income people save more.” Toder notes that the proposed change’s effect will “not be significant for those on the upper end” of the income scale.

Other analysts are more skeptical about the long-term impact of the proposed change, noting that “it is never clear whether a policy change will broaden the scope of those contributing to retirement accounts, since there is no way to tell in advance if more people will contribute to retirement accounts with the tax credit system rather than tax deferrals.” Such changes could also result in higher-income individuals move to a Roth IRA or some alternative retirement-saving tool. Still others fear that such changes might become a disincentive for small businesses currently willing to have a 401(k) plan and to make match contributions.

Biden’s proposed changes would also include the automatic creation of a 401(k) account for workers without a workplace retirement account and allowing caregivers to make catch-up contributions.

Watch this blog for updates on 401(k) changes and other tax-related news.