As congressional republicans continue to work on tax reform legislation, many media reports have mentioned the possibility of significant changes to the current 401(k) retirement plan structure.
Today a 401(k) plan participant may elect to defer on a pre-tax basis (no current income tax) up to $18,000 ($18,500 in 2018), plus another $6,000 if the participant is age 50 or older. Amounts deferred on a pre-tax basis plus earnings are includable in gross income for income tax purposes when distributed to the participant. Alternatively, if the plan allows it, a participant may elect to defer some or all of these amounts on an after-tax basis as a “Roth” 401(k) contribution. Roth contributions are includable in gross income for income tax purposes when contributed, but provided certain holding rules are satisfied, the earnings on the Roth deferrals are distributed tax-free.
The most significant reported possible changes to the current rules are:
- Employee contributions would be allowed up to $2,400 on either a pre-tax or Roth after-tax basis
- Employee contributions above $2,400 would have to be made on a Roth after-tax basis
Taxing employee payroll deferrals into 401(k) plans would result in substantially increased tax revenue today, though it would reduce future tax revenue since the contributions would not be taxed at distribution. There is concern among employers that if employees can’t contribute more than $2,400 to a 401(k) plan on a pre-tax basis, many will cap their deferrals at $2,400, ultimately reducing their overall retirement savings.
Employees concerned about the “Rothification” of 401(k) plans should consider increasing their pre-tax contributions for 2017 and contacting their representatives in Congress. But tax reform aside, an employee’s retirement readiness will improve by regular, systematic contributions to a retirement program, whether pre-tax or not.