Reduced 401(k) Tax Deduction? So What?

Tax Reform Proposal capping 401(k) contribution

Word on the street this week is that deductible 401(k) contributions could be capped at $2,400. President Trump then rescinded that idea. Previously, there were stories that the deduction for 401(k) plans would go away completely.

What replaces a deductible 401(k) isn’t clear… there could be Roth accounts or non-deductible accounts.

It is well documented that Americans aren’t saving enough for retirement. By reducing the deductible amount to 401(k), one would think that this policy would only exacerbate the issue.

But will it?

Is the American cohort who doesn’t save enough for retirement saving the maximum $18,000 (the current deductible limit)? Are the 401(k) maximizers people who will save anyway? Are the “under-savers” saving closer to the proposed $2,400 limit?

I don’t know the answer to any of those questions, and it’s not my job to know.

It’s my job to understand how the tax code works. The first thing to understand is that the tax code is a book of incentives.

Income taxes were established to generate revenue for the government. The tax code is dedicated to reducing taxes.

To create the desired behavior, Congress creates tax benefits (ex: deduction for 401k contribution).

If Congress eliminates a tax benefit, then it could be a signal that the tax benefit wasn’t working as designed. It could mean the newer Roth account is better for the average saver. I don’t know.

My thought is that the tax reform team read my article on choosing between a 401(k) and Roth 401(k) and realized that a Roth 401(k) is great for the average saver. 🙂 Ha, more likely they read the Harvard Business Study, but it is fun to pretend. And yes, if implementing an advanced tax strategy, then yes, the loss of the deductible 401(k) will be disappointing.

What should you do?

The law isn’t in effect. It’s part of the reconciliation and negotiations in tax reform.

Because we don’t know what will happen with legislation, here are my recommended steps:

  • Continue with your savings strategy!
    • If you’re already contributing to a Roth 401(k) keep doing it!
    • If you’re already contributing to a Regular 401(k) keep doing it!
  • Consider taking advantage of the tax incentives available while they last!
    • Don’t take for granted that the full $18,000 tax deduction for your 401(k) will last forever. This is a good signal that it won’t.
  • Focus on your savings rate.
    • Compound interest doesn’t care if there are tax incentives. The more you save, the more compound interest will be your friend.
      • Yes, a tax shield will help your outcome, but your stock/bond investment will be taxed in this life or the next anyway.
    • If you stop saving because the tax law changes, then you are missing out on the benefits of compound interest. Save early!
      • The earlier you save, the more doubling periods you can experience with your money.
  • Invest in rental real estate or business? It’s one of the paths to Early Retirement.
    • Tax reform is targeting greater incentive for these types of investments too.

Keep saving!

 

Do you want to understand how to make your money work for you and keep more of what you have earned? 

Reach out to me at nbyers@jbcwealthadvisors.com or schedule a free consultation.

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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Nate Byers a Madison, WI CPA Financial Advisor,  and all rights are reserved. Read the full Disclaimer in the footer below.