Tax Reform: The Retirement Plan Tax Changes that I Would Recommend
Last week, the House introduced the much-anticipated Tax Cuts and Jobs Act. Those who work closely with retirement plans, including retirement plan sponsors and advisors like myself, have been waiting with bated breath to see how the House suggests raising revenue to pay for income tax cuts - and what that could mean for retirement plans.
Now, in a world where I get to set tax policy, I would focus on making retirement plans even more attractive from a tax perspective (e.g., raising deferral limits). Luckily for me, I don’t plan to run for Congress anytime soon, since my ideal scenario would not raise revenue.
While my humble opinion was not sought in drafting the bill, let’s take a few minutes to consider some practical changes to retirement plans that the House could have considered that would raise revenue without having a major impact on retirement plan participants.
Here are my suggestions:
- Get rid of the 15-year catch-up election for 403(b) plans, which permits additional elective deferrals to 403(b) plans for certain employees — Eliminating the 15-year catch-up election would raise revenue, as it is a tax break - albeit one that is often misunderstood. Per my previous rant, the election is needlessly complicated, useless for many, and a target of IRS auditors. Getting rid of it is long overdue, but I am not holding my breath.
- Abolish the Saver’s credit, which provides a tax deduction for those with modest incomes on their retirement plan/IRA savings — Okay, before you jump all over me for eliminating a tax break for those with modest incomes, hear me out. The credit is non-refundable, meaning that it can only be applied as a credit to taxes owed. If an individual’s tax liability is zero or they are owed a refund, the Saver’s credit is worthless, since it will not increase the amount of their refund. As a former earner of modest income, I can tell you first-hand that modest income earners generally receive refunds on their tax returns. Thus, this often misunderstood credit is useless to them. Of course, in my ideal world, I would make the Saver’s credit refundable, but since that would not raise revenue…
- Reduce the extremely high amount that employees of some tax-exempts/governmental entities can defer — I promise that I am not going all Richard Thaler on you. I personally do not support Rothification of all or any portion of the current general elective deferral limit to 401(k)/403(b) plans, which is scheduled to be increased to $18,500 in 2018. The Roth option has been a massively unpopular election thus far, and in my opinion, forcing it on people will no doubt discourage retirement plan savings at all income levels. Having said that, there is a quirk in the tax law that permits employees who are eligible for both a 457(b) AND a 403(b)/401(k) plan (assuming their employer sponsors both plan types) to defer up to $37,000 in 2018. And, if an employee is age 50 or older (as of 12/31/2018), they can defer up to $43,000 if they work for a non-governmental employer, and up to $49,000 if they work for a governmental employer. While I am a strong supporter of robust pre-tax deferral limits for all employees, these enhanced limits seem a bit excessive. It is likely that individuals deferring at this level are high income earners who already have large retirement plan account balances. As I indicated in a previous Top of Mind, for those with larger account balances, the ability to defer at a high level is less important to retirement security than prudent investment of their assets. Thus, if we reduced the combined 403(b)/401(k) and 457(b) limit to, say, $25,000, the people we would be “harming” are far less likely to need the extra deferral amount for their retirement.
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
Investment products available through Cammack LaRhette Brokerage, Inc.
Investment advisory services available through Cammack LaRhette Advisors, LLC.
Both located at 100 William Street, Suite 215, Wellesley, MA 02481 | p 781-237-2291