Will Congress ruin your retirement? That’s the upshot of some news coverage from Washington, D.C., where Congressional tax negotiators are supposedly considering reducing the threshold for contributions to a 401(k) plan that are tax-deferred.
That might sound like an assault on middle-class living standards. But if done right, trimming the upper limit for 401(k) contributions would mostly affect the wealthy while raising new federal revenue that could be used for tax cuts more likely to benefit the middle class. Democrats, in fact, have pushed for such moves before. “Modestly scaling back the cap on 401(k) contributions should have only a small impact on saving, but could raise some real tax revenue,” says Mark Zandi, chief economist at Moody’s Analytics.
President Donald Trump has insisted there will be no reduction in the 401(k) limit. But key members of Congress, such as Rep. Kevin Brady (R-Texas), chairman of the powerful House Ways and Means Committee, have pushed back on that. “We’re looking at a number of ideas,” Brady said at the Yahoo Finance All-Markets Summit on October 25. “If any changes are made, we’ll do that in concert with the White House.”
The current maximum for tax-deferred contributions to a 401(k) plan is $18,000 per year per worker. But only about 10% of all taxpayers contribute that much, and they’re mostly wealthy. In the latest annual report by Vanguard, the median 401(k) contribution was just 5% of income, with the median income of workers participating in a 401(k) plan about $65,000. So a typical 401(k) contributor puts about $3,250 into such a retirement plan per year.
I looked at my own 401(k) contribution, and it’s way below the $18,000 maximum, even though I wish it were higher. I asked a few friends and colleagues—none of them rich—whether they hit the maximum amount. Most didn’t come close. A few did contribute the maximum, but mainly because of lucky circumstances, such as living with a girlfriend and not having to pay rent.
Democratic precedent
Lowering the threshold for contributions to tax-deferred retirement plans has actually been Democratic policy in the past. In 2013, President Obama proposed a cap on the total amount of retirement funds that could be subject to tax breaks, which would only have affected people with large retirement accounts. It didn’t target 401(k) plans specifically—and it didn’t pass—but it established a precedent for seeking savings from rich retirement plans.
The left-leaning Center for Budget and Policy Priorities published an analysis in 2013 showing that 66% of all retirement tax incentives accrued to the top 20% of earners, with the middle fifth enjoying just 9% of the benefit, and the bottom fifth only 2%. David Axelrod, who was a key adviser to Obama, tweeted on October 26, “How many working Americans can afford to put $18,000 in their 401(k) accts per year? Seems like very few. Why NOT cap it at a lower number?”
A populist move
A key question, of course, is what the new lower limit would be. Some news reports suggested it could be less than $3,000, which would be a huge change affecting many middle-income people—and sure to cause an uproar. If not wildly off-base, such news leaks are probably meant either to test how severe public blowback is to such a radical idea or to make Republican plans sound more severe than they’re likely to be. Either way, it’s not politically feasible to propose middle-class tax cuts that somehow make saving for retirement harder.
But lowering the annual limit to $15,000, $12,000 or even $10,000 could plausibly qualify as a populist move if the revenue it brings in helps lower the middle-class tax burden in some other way. “If the cap was reduced to, say, $12,000, I don’t think saving would be significantly impacted,” says Zandi. And that could raise about $300 billion in revenue over the next 10-years. It’s possible to put some of that money to better use. Congress will begin releasing details of the House and Senate tax plans in early November, so honest taxpayers can at least wait till then before panicking. Maybe longer.
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Rick Newman is the author of four books, including Rebounders: How Winners Pivot from Setback to Success. Follow him on Twitter: @rickjnewman
