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Gutting the 401k: The Stupid Party Digs in Its Heels
On Sunday, I posted a piece with this title and a slightly different subtitle, observing that the mainstream Republicans seem to have a death wish, drawing attention to the pitiful record of the Republicans in Congress when it came to delivering legislation to the President’s desk, and adding:
And when they come to tax reform, what is their big idea? To cut corporate taxes, which would be a boon, and to make up for the revenue losses that this would entail not by cutting expenditures but by gutting the 401k . The fact that their proposal that tax-free contributions to this retirement-savings vehicle be cut to $2400 a year has Wall Street up in arms bothers me not one whit. It is not the task of the US government to feed the greed of a particular industry.
It is its effect on the ordinary joe that I have in mind. I mean the fella who plays by the rules, works hard, and socks money away for his retirement, using the 401k. If self-reliance is a virtue and if promoting individual self-reliance serves the public good, as it surely does, then the provisions within the tax code providing for the 401k are among that code’s best provisions. From the perspective of macroeconomics, the 401k promotes capital formation. From the perspective of public policy, it reduces dependency. What’s not to like?
Moreover, subverting the 401k is bad politics. If Wall Street is up in arms, think about the fury that legislation of this sort will elicit from the ordinary joe once he feels the pinch. Are the Republicans in Congress so beholden to the Chamber of Commerce that they have forgotten their party’s base? If they gut the 401k, in 2018, they will lose both the House and the Senate in a landslide. Is there no one in the Republican Party’s congressional leadership who has any sense?
When this appeared, I was immediately taken to task by a member who argued that the Republicans had done a lot (though he had to concede they had actually passed next to no legislation). Then, with regard to the 401k, he added:
[C]an you inform us where, exactly, you saw this in print? Please provide the link, because I have only seen it one time, in an AP wire story last week, reprinted in WaPo and their left-leaning brothers. I’ve been looking for it ever since and can’t find it. I think a link to the actual “proposal that tax-free contributions to this retirement-savings vehicle be cut to $2400 a year” would be much appreciated, so I can be as outraged as you. I will write a letter to Cruz and Cornyn (I’m from Texas) and to Trump and Pence, once I have the proof in hand.
If you are only going to quote the AP story, I think a retraction would be nice.
This individual’s attention was then called to a similar piece in The Wall Street Journal, reporting, “Lobbyists and others in the retirement and financial services industries who have spoken to congressional staff and committee members say lawmakers are looking at proposals that would allow 401(k) participants to contribute significantly less than what is currently allowed in a traditional tax-deferred 401(k). An often mentioned amount is $2,400 a year. It isn’t clear whether that would only apply to 401(k)s or IRAs or both.”
To this, he responded with incredulity, “[I]n my book, that’s nothing but gossip. We’ve got ‘lobbyists and others’ who have spoken to ‘staff’ and etcetera say lawmakers are ‘looking at proposals’… and ‘An often mentioned amount is $2,400 a year’…”
As you may be aware, there has been a great deal more in the press recently about this supposedly fake news. One could, of course, suppose that — when the President of the United States intervened to indicate that he was opposed to gutting the 401k — he had been fooled by “gossip.” But it makes more sense to suppose that the Associated Press and The Wall Street Journal, not to mention Pravda-on-the-Hudson, had done some real reporting.
As it turns out, some very important Republicans are still intent on gutting the 401k. Yesterday, The Weekly Standard reported that — Donald Trump’s objections notwithstanding — Kevin Brady, chairman of the Ways and Means Committee in the House of Representatives, was still interested in the project. And there is a similar story on the front page of today’s Wall Street Journal., which once again intimates that the Republicans are thinking about restricting tax-free contributions to $2,400 a year.
I understand the propensity to regard the mainstream media as suspect. When Pravda-in-America in its various guises reports on Donald Trump, there tends to be an admixture of fiction with fact. But it is a mistake to respond reflexively in utter disbelief to news reports suggesting that the Republicans in Congress are on the verge of doing something really stupid. They, alas, do such things quite frequently.
In this case, however, it looks as if Donald Trump (who is more often than not underestimated) will wade in to save the congressional Republicans from themselves.
Published in Domestic Policy
That depends on the rate of inflation, doesn’t it?
I like 401(k) because:
Look I don’t mean to sound course here but these are not subsidies. These are either pre-tax deductions, which means you earn the money and before the Feds can come along and get their cut you put it in a 401k, or it is a deduction on the amount they get to keep after they have their cut when you file on April 15. This is your money! You are entitled to the fruits—all of them—of your labor. Please use the proper language.
Mortgage Deduction, we agree. But tell me this: people keep voting for State Socialists, who keep raising their State Income tax, but then the Federal government, via MY taxes, gives it back to them? I love to bash California because I am a Texan, so let’s go there. Some tree-hugger in the Bay Area votes for Governor Moonbeam, and he pays 10% of the $100,000 he makes to Moonbeam. Then Congress puts a gun to my head and takes that ten grand out of my wallet and sends it to the tree-hugger! Where is MY entitlement in that transaction?
This is the crux of it, 401(k) is the new pension plan. If they are going to limit the tax deductible of the 401(k) they will have to also start taxing the value of pension plans also.
A 401(k) plan is just a pension plan where the employee takes on the market risk rather than the employer.
I think this $1800 number is suspect. Is this a lie with statistics? i.e. The average worker may contribute less than $1800 a year to 401(k) plans, but does this include employees that don’t contribute to a 401(k) plan at all? The better statistic would be the median annual contribution to 401(k).
Also does this include employer matches? Employers can often match 1:1 upto a few percent, and sometimes contribute a couple percent of income with no match.
Before the 401k, there was something called a 403b — which was how academics saved for retirement. I am not sure when it was invented, but the Carnegie Foundation had something to do with it, and it went way back. In consequence, the inventors of the 401k (Newt Gingrich prominent among them, if I remember correctly) had something to study, and it was worth studying. For it served the academics who worked in the private sector very, very well. It provided for steady saving, and it produced an investment in the stock and bond mutual funds via dollar-cost averaging. I have had a 403b now for forty years, and the results have been very, very good. If Kevin Brady and his crew fool with this, they will alienate a great many, hitherto reliable Republican voters and produce a landslide for the Democrats.
Maybe I am misunderstanding what SALT is in tax parlance. I was talking about mortgage deductions and the pre-tax 401k contribution. Deducting state income taxes seems a bit odd to me. In Maryland we have to count the amount in our return in the next year’s filing. Meaning they are taxing a portion of the total income twice. Let’s say you make 100 bucks and the Feds withhold 30 of it but you get 15 back. The Feds are looking at the 100 as your total. Maryland does too and then withholds their scrape. But when you file that next year, the Feds withhold from 100 while Maryland is going to withhold from 115. Even though they scummed off that 15 the previous year. It’s despotic here man.
No question saving for retirement is a good thing. As Milton Friedman said regards Social Security, saving up to buy an annuity when we get too old to work is something we all know we need to do. Most of us do. But the question is–similar to that for SALT and mortgages–why the hell are you people paying for my extravagant retirement? I’m just wasting your money. Trust me.
I was futzing around with a future value calculator this morning (thinking about exactly how bad a deal Social Security is for the lowest wage earners–and everybody else). $2400 a year, untaxed, for your working life will git ‘er done at a conservative rate of return. No one says you can’t save more or invest more wisely. And even legally dodge taxes doing so, squirrelly creation that our Tax Code is.
Oh. No, SALT is short for State and Local Taxes (deduction) from your federal Income Taxes. Click the link; it’s real. The original idea was that your are being taxed twice on the same income, but the reality is that you are just paying more taxes because of where you choose to live.
Or maybe I’m wrong? I’m trying to figure out if this means my Mortgage Deduction, too. Help @catorand !!
Wow, I hope Michael gets in here and tells us where he got that news. Even the ex-Newsweek Fake News reporter wasn’t saying that. I wonder if he inferred it somehow from the WSJ story?
I see it differently, Albert. If I am making $500K a year now and contributing 10% and my company matches up to 10%, I am not only doubling my money invested, I am paying no taxes on it. If I pay off my house before I retire, I can live on $80K a year and pay, what, 15% instead of the 38% I’d pay on my current wages. The Roth, on the other hand, is only my money and I am getting hit with 38% tax.
Unless I am missing the math, my 401(k) sounds like the better deal.
SALT can stand for whatever you want but as I understand it eliminating the mortgage interest deduction is off the table as it stands. Mortgage interest is definitely a different line item on Schedule A.
Of course once they start messing with things, anything can happen, but to date they’ve been very firm about not cutting the mortgage interest deduction.
Ok, but in terms of what the New Jersey, New York, and California Republicans were freaking out about (and they were the 20 Republicans who didn’t vote for the Budget Bill) do you know what SALT they are eliminating?
EDIT: Ok, I verified it, they are not talking about Mortgage Interest or Mortgage Taxes. They are only speaking of State and local Income Tax and Sales Tax.
There is no “mortgage tax.” It’s property taxes that are currently deductible (in addition to income and/or sales taxes) and all of those are on the potential chopping block but not mortgage interest. Look at this way, if you pay it to a bank, it appears it’s likely to stay deductible, if you pay it to any state or local government (on whatever basis) it’s at risk.
Yeah, heh heh, I was in a hurry and just slapped it out there. Mortgage Interest is still deductible. Property taxes may not be. Got it.
One thing is for sure, we’ll all be watching!
Also missing in the analysis is the “opportunity cost” when you pay the taxes up front. You lose the potential growth which can more then offset the taxes paid later….
Nope:
1. Assuming identical tax rates at contribution and distribution, $1,000 saved as a Roth contribution produces the same tax benefit as it would if saved as a regular 401(k) contribution.
While not particularly intuitive, this equivalence is a commonplace. Here’s a simple version of the math: Assume two taxpayers in the highest marginal bracket (39.6%) at the time of contribution (year 1) and the time of distribution (year 10) and a 5% earnings rate. They both want to save $1,000. One makes a regular 401(k) contribution; one makes a Roth contribution. The following table shows what they will get at distribution.
Bottom line: the regular contributor doesn’t pay taxes on the way in, but does pay on the way out; the Roth contributor pays taxes on the way in but not on the way out. They both wind up with the same amount at distribution, net of taxes.
You’re right about the math, but I’ve observed that Roth’s have the added benefit of causing people to save more in many cases. People pay their taxes and don’t think of that as savings, but by – relative to a traditional IRA – “prepaying” the taxes, and then funding the Roth to the same level, they effectively save more. That’s why I like Roths so much. That and the fact that the tax diversification gives you some options for avoiding the higher tax brackets in the distribution phase – i.e. it gives you options to keep your retirement tax rates (on money withdrawn from your traditional retirement accounts) at or below your working tax rates. If retirement tax rates are below working tax rates you’ve “won the game” with the traditional contributions.
You can also withdraw your Roth contributions prior to retirement without penalty, since you’ve already paid tax on it. If you try to pull money out of a regular account, you get drilled.
Again, depending on the rate of inflation. And, accordingly, depending on your risk tolerance.
As a general rule, I would say that if you can avoid paying a tax now, take the opportunity rather than taking a government promise that they won’t tax you in the future. But then again, I don’t have a lot of faith in government promises.
Yeah it is not supposed to affect your Mortgage Deduction. However owning a house gets you 2 deductions under current law. The Mortgage Deduction and a deduction for your property taxes. I would have to find the link, and country wide averages are rough, but the average property tax payment in the country is like $3,000. This is deductible now but would not be under the proposal. So any changes to the individual brackets would have to benefit a tax payer by more than what they get out of this deduction or you have wide spread middle class tax hikes not cuts.
For those who itemize. Most (even homeowners) don’t. And if what they’re saying about doubling the standard deduction is true, even fewer would do so after the reform.
Remember, tax deductions only have value to the extent that they exceed the standard deduction. In 2016 for a married couple, is was $12,600. So you’d have to have mortgage interest, and state taxes and property taxes (Plus other schedule A deduction – probably the main other one is Charitable contributions) greater than that amount before there is any value.
Which also means the loss of deductibility is not really of the whole amount. Let’s say for the sake of argument you have total itemized deductions of $16,000. In that case, only the last $3400 of deductions “matters”. You’d get the rest anyway via the standard deduction.
I was just about to say that – if they double the standard deduction, I’ll never benefit from itemizing again. Hello, 1040EZ, my old friend!
My late aunt was a teacher and she bragged all the time about her 403b and frankly, she had a very comfortable retirement, so you are correct on that. She probably would have bought a shotgun and headed to DC if anyone had messed with “her money” in any way.
It was her influence from her lifestyle that sold me on building a big 401(k) from as early as I could.