How Could Tax Reform Hurt Retirement

Gina Deveney
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Tax reform is a high-priority item for the Trump administration in 2017, and the Republican-controlled Congress hopes to approve a tax reform package that cuts taxes for individuals and corporations without increasing the federal deficit. Although the particulars of tax reform are still under debate, possible changes to retirement plan regulations may be put into place to help make up for lost tax revenue. Here are few things to watch for in tax reform proposals.

Changing 401(k) Contribution Limits

Brian Graff, executive director of the National Association of Plan Advisors, anticipates a possible freeze or lowering of 401(k) contribution limits. One possibility is that current limits would stay in place for an extended period without the benefit of cost-of-living increases. Another option might be setting a lifetime cap on total 401(k) contributions. A plan that directly lowered annual tax-deferred contribution limits would have an even stronger effect on the ability of workers to save easily for a comfortable retirement. Simply lowering tax brackets might discourage retirement saving in general if workers see less benefits to deferring taxes on a portion of their income. Regularly remind your clients of the benefit of having adequate retirement savings to help them make responsible choices.

New Ways of Taxing Retirement Savings

Future tax reform packages might minimize tax-deferral options for higher income workers. For example, workers in the top tax brackets might only be allowed a 25 or 28 percent tax deferral, paying 5 to 7 percent tax on their 401(k) contributions at the time they invest it. This money would still be taxed at a regular rate when disbursed at retirement, so that a portion of the money would actually be taxed twice. This would bring in additional revenue for the government but might ultimately offset the tax advantages of any tax reform plan to higher income workers. Encourage your clients to take steps to protect their retirement savings to help offset these types of changes should they occur.

Eliminating 403(b) and 457 Plans

403(b) and 457 plans help school employees, ministers, employees for nonprofit organizations, and state and local government employees save for their retirements. In addition to being tax deferred, some of these retirement plans also offer savers a tax credit up to $1,000 to encourage saving. Eliminating these plans would increase revenue by eliminating the tax deferral benefit and the tax credit, but it would leave those currently using these plans struggling to find new options for retirement savings.

Any tax reform is likely to affect retirement investing in some ways, so be prepared to explain changes to your clients and offer new options for retirement savings. Share the value of diversifying investments to prepare for an uncertain future. Regularly review current investments, and offer frequent updates to share the effects of any tax reform package on retirement savings plans.

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