The discussion about possible changes to annual 401k contributions continues. Republicans say that reducing tax-deductible contributions today will increase tax revenue. Democrats say that raising contribution limits will help people save more for tomorrow. Let me share some issues of genuine concern regarding both approaches.
Most of the families we serve either earned too much money to qualify for a Roth contribution (there is no income limit for a Roth 401k contribution), or retired shortly after the Roth was introduced in 1998. In short, the majority of their retirement savings are held in tax-deferred investments. People concerned about losing tax-deferred investment opportunities have not seen what happens to retirees when Required Minimum Distributions (RMB) begin at age 70.5.
Deferring taxes feels good in the moment. But the pain of paying taxes when mandatory withdrawals begin has left more than one of our families in tears. That unfortunate situation is especially sad when one spouse passes away. One widower asked me, “Joe, why should an 82-year-old man be forced to withdraw $94,000 and pay taxes on it at a high tax rate?” He asks a good question. As always, you either pay the IRS today or you pay them later.
The other side of the aisle wants to increase tax-deferred contribution limits. They reason that higher limits will encourage people to save more for retirement. But realize that most young families are not fully taking advantage of today’s maximum contribution limits. Increasing the amount of taxes that unsuspecting future retirees can defer today is not helpful for several reasons.
We favor neither option because we don’t like regulations that force investment behaviors. Working in this industry for 30 years, I’ve seen that families who can contribute the maximum amount to their 401k continue to do so, regardless of tax deductions. These folks will complain about a lost deduction because they are natural savers. The families who don’t save for retirement are already paying taxes on their income so the change in contribution limits won’t change anything.
Raising limits on tax-deferred contributions will allow people who don’t plan well for future tax rates to put themselves in greater jeopardy today. This approach is like tax cocaine. It may feel great at the moment, but the morning is coming! Who doesn’t want to pay less in taxes today?
Financial journalists will share the viewpoints of those who benefit from tax deferrals. Such entities include insurance providers and mutual fund companies. These businesses have skin in the game if tax-deferred contributions are increased or lowered. Let’s focus on where we are today. Let’s make the best decisions possible. When things inevitably change, we will help families create the best strategy based on their unique situation.
Perhaps the only thing I can do as a fiduciary that is more important than getting you on the right track today, is assuring you that I will be here tomorrow when things need to change.
Tax advice provided by CPA’s affiliated with Financial Enhancement Group, LLC.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.