Optimism from past weeks regarding the fate of 401(k) tax benefits under tax reform is beginning to wane, with some signaling that employees would have to pay taxes upfront on at least a portion of their retirement savings.
Mark Iwry, a non-resident senior fellow at the Brookings Institution and a former senior Treasury Department official who served under President Barack Obama, is one who believes the Republican majority in Congress will mandate at least a certain portion of 401(k) contributions be diverted toward Roth accounts.
The rationale would be to shift retirement-plan contributions away from traditional pre-tax accounts as a partial way of
raising revenue for desired cuts in individual and corporate tax rates.
"Yes, we will get tax cuts sooner or later, and the Rothification will be a likely part of it," Mr. Iwry, who served as deputy assistant secretary for retirement and health policy at the Treasury Department, said Thursday morning at the Defined Contribution Institutional Investment Association's annual Academic Forum in New York.
"My guess is: full Rothification, no, off the table, too extreme and too politically sub-optimal. Partial Rothification, yes, seems highly likely," he added.
"Full" Rothification would entail a mandated 100% use of Roth accounts for 401(k) savings, while "partial" would dictate only a certain portion of savings be Roth.
A shift to Roth accounts, which tax retirement savers upfront rather than upon withdrawal (as occurs with pre-tax accounts), would pull 401(k) tax revenue within the 10-year budget window the government uses to "score" federal tax revenues.
In a report earlier this year, the Joint Committee on Taxation estimated defined contribution plans would cost the government $583 billion in tax revenue between 2016 and 2020.
Some observers believe the policy would
hurt low and middle income savers who value the upfront tax break on savings, and therefore may lead to less savings or fewer people to save.
Stephen Zeldes, a finance and economics professor at Columbia University's Graduate School of Business, citing research from the Investment Company Institute, said there's roughly $15 trillion in traditional, pre-tax savings in 401(k)s and IRAs, and less than $1 trillion held in Roth accounts.
"I wish the [Roth] discussion were focused on [retirement security]," Mr. Zeldes said. "Unfortunately, I think the main reason this is being talked about today is to get revenue into the budget window."
Officials in the administration of President Donald J. Trump are pushing to get tax legislation passed by the end of the year. However, many details of the tax package remain a mystery. The most recent tax outline released by Republican leadership
didn't allude to any specific tinkering with 401(k)s, saying only that the framework "retains tax benefits that encourage work, higher education and retirement security."
While that language left some
feeling rosy about the security of 401(k) tax benefits, it still leaves room for changes in the structure of 401(k) deferrals.
One commonly cited legislative
proposal is that of former Representative David Camp (R-Mich.), who was chairman of the House Ways and Means Committee from 2011-15, which called for up to half of elective 401(k) deferrals to be pre-tax, with the remainder in Roth. (That equates to a $9,000 ceiling in 2017.)
Mr. Iwry believes Republicans would reduce that threshold to $3,000, which is the current median level of 401(k) contributions.
Congress could also seek to "reverse engineer" the threshold, by determining the threshold that would deliver a level of desired revenue, such as $500 billion, he said.
"My concern is that with Rothification, you could raise that kind of money, and that's the kind of money they may well be targeting," Mr. Iwry said.
