Blog : Republicans set to throw your 401K plan under the bus

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4/29/2016 6:45 am

Republicans set to throw your 401K plan under the bus

Source: Forbes

Is your 401(k) retirement plan tax deduction in peril?

Rep. Paul Ryan’s (R-W

tax plan to lower marginal tax rates depends on broadening the tax base. Of course, broadening the tax base requires reducing “expenditures” or reining in tax deductions we are all used to.

As soon as you start looking for deductions to cut you run into sacred cows, and one man’s legitimate deduction is another man’s obscene loophole.

However, not all expenditures are created equal. Let’s compare two of the most important. Regardless of the merits, Americans expect to deduct their mortgage interest on two houses, and they are very fond of pretax contributions to their pension plans and 401(k)s.

Both expenditures might be likely targets of the new and improved flatter tax proposal currently being debated.

A mortgage interest deduction encourages consumption. You can treat yourself to a vacation home or even a yacht to qualify as a second home. Or you can just splurge on a McMansion. Depending on your viewpoint, you can consider this deduction a sacred right, part of a dysfunctional housing policy, a distortion of capital markets, or an important national economic objective.

The 401(k) deduction is an entirely different animal which encourages savings rather than consumption. In a society with almost zero net savings, there is a far better argument for an incentive which encourages savings and investment rather than consumption.

I’m the first to recognize that the 401(k) is an imperfect pension system, but, it’s one of the few bright spots in our savings ability. Families that have access to a 401(k) have twice as many savings and investments as families that do not. To the extent that a tax advantage encourages savings, it’s a more defensible expenditure.

Here’s another huge difference: If I take a mortgage interest deduction, the value of that deduction is gone forever from the U.S. Treasury. It’s never going to be re-captured, but a regular 401(k) contribution is a tax deferral. The value of the deferral amount and all its future earnings must be recaptured in the future when the funds are ultimately distributed to the taxpayer.

Of course, if the government is determined to get theirs up front, they could change the entire 401(k) system into a Roth like program: Pay the taxes on your contribution now, but get tax free income in retirement. The IRS can book the income earlier, but the total tax receipts over the lifetime of the taxpayer will be little changed.