Is Trump Going To Take Away Your 401(k)?

November 02, 2017

You’ve probably seen the headlines about the latest tax proposal working its way through Congress and perhaps you’ve heard that there are proposed changes to the way 401(k)s work. How can you tell the fake news from the stuff you should worry about? Here’s how I see it:

What it is: The big thing going on is the discussion about limiting pre-tax contributions to qualified retirement plans (like 401(k) accounts) to $2,400 a year as a way to help pay for tax cuts. If you’re currently contributing more than that pre-tax, you would see your current income taxes increase. However, you will likely be able to make after-tax Roth contributions up to the current limits or an even a higher $20k annual limit. As long as you’ve had the account for at least 5 years, these Roth contributions can then be withdrawn tax-free after age 59 ½.

What it isn’t: Nothing will happen to the money that you already have in the plan — that’s not what this is about. It’s also highly unlikely that total contributions would be capped at $2,400. That would be incredibly politically unpopular, plus preserving the Roth option allows Congress to claim that they’re not raising taxes overall since the higher taxes today would be offset by lower taxes on the future Roth withdrawals. (That loss in revenue to the government wouldn’t be until most of the current politicians are conveniently out of office.)

Should you worry? If this passes, you would no longer have the option of reducing your taxable income by more than $2,400 a year via contributions to your 401(k), so if you currently contribute more than that pre-tax, it would mean higher current tax bills. The silver lining is that those without a current Roth option in their 401(k) would likely get it.

Roth contributions have several advantages over pre-tax contributions:

If you plan to retire before being eligible for Medicare at age 65 and purchase health insurance through the Affordable Care Act, tax-free Roth withdrawals do not count in determining your eligibility for health insurance subsidies, which can make your health insurance premiums a lot more affordable.
Tax-free Roth distributions may mean less of your Social Security income would be taxable.
If you lose a lot of deductions in retirement (like having your mortgage paid off and/or moving to a state with lower state income taxes), taxable withdrawals from your 401(k) could put you in a higher tax bracket — you don’t have that problem with Roth.
Similarly, tax-free Roth distributions can protect you from the risk of higher tax rates in the future.
By rolling your Roth 401(k) into a Roth IRA, you can avoid required minimum distributions and eventually pass on more to your heirs.

What you can do now: If the ability to save pre-tax for retirement is important to you, take advantage of your ability to make pre-tax 401(k) contributions while you can and keep in mind that even if the 401(k) didn’t exist at all, you can always save for retirement in IRAs and regular taxable accounts. The decision of where to put your retirement savings is secondary to how much to save to begin with.

That being said, use this controversy as a spark to learn more about pre-tax and Roth contributions and how you can benefit from whatever opportunities are available to you. Remember, neither Trump nor Congress are ultimately responsible for your retirement. You are.

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