On Friday, the New York Times reported that House Republicans are proposing to lower the annual pre-tax 401(k) contribution from its IRS 2018 allowable amount of $18,500 to $2,400 in hopes of raising revenue to finance nearly $1 trillion in tax cuts. That proposed tax plan would not only be disastrous to the middle-class, but will also have a major impact on both employer contributions and the employee (and remember, if you're a business owner, you're an employee too).
In response to the report, President Trump tweeted on Monday, "There will be NO change to your 401(k). This has always been a great and popular middle class tax break that works, and it stays!" When Rep. Kevin Brady (R-TX) was asked whether Trump's tweet changes the House's tax overhaul plan he responded, "No" and said Wednesday that Republicans are working with the White House to ease the president's concerns.
Contributions to 401(k)s are tax-deferred, which means that the government cannot get its cut until retirees start withdrawing money from those accounts -- which they must do by age 70.5. What we have in the cross-fire is $82.7 billion in lost revenue in the recent budget year ending Sept. 30, 2016 -- a potentially juicy target for Republican tax-cutters.
Here's what that would mean for small businesses across America,
Employees would likely contribute less to IRA accounts
If the proposal passes, there is a strong indication that U.S. workers will either shift their savings to Roth Individual Retirement Account (IRA) accounts, where contributions are taxed immediately or employees and employers will contribute less for retirement.
Demos, a non-partisan public policy research and advocacy organization, issued a report called The Failure of the 401(k) which stated that most workers in the bottom quarter of the income distribution do not have access to workplace retirement benefits. For those that do have workplace retirement plans, employees rarely hit the IRS max contribution. Many workers believe the government's cap is an implicit endorsement of the optimal savings level and work toward that target.
For those employers that have a retirement plan for employees and match a percentage of the employee's contributions up to a specified dollar amount or portion of salary: If the allowable amount drops from $18,500 to $2,400, you may be less inclined to match more than what your employees are contributing.
This would result in higher profit margins and lower costs. Then, in turn, it would have a domino effect on your matching contributions. If employees are contributing less, employers will match less. While owners could still contribute more than the $2,400 cap they still may want their employees to take ownership of their own retirement.
You'd need an alternative--for both your business and yourself
The proposed plan may backfire on the GOP, as they may not recoup the tax revenue they expect. Furthermore, workers saving less for retirement could result in many working at an older age and possibly relying more heavily on social security and Medicare. That would have a dire consequence for the economy.
I suggest you start looking to other retirement plans as alternatives. Both the SIMPLE IRA and Roth IRA provide generous tax breaks. Do your research and contact investment management companies in the event that the GOP's tax reform plan passes and negatively impacts your 401(k) employee and employer contributions.