Tax-privileged retirement accounts such as 401(k)s could be collateral damage of a gimmick meant to help Republicans pass a sweeping overhaul of the federal tax code.
Employers and financial institutions worry that the idea, known to tax writers as “Rothification,” is among the budget tricks that the taxwriters are considering to finance tax rate reductions.
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The gimmick would work by changing when employer-provided retirement plans such as 401(k)s are taxed. Under current law, workers put earnings into those plans before paying taxes on them and then face taxes when they withdraw them.
Congress could change the rules so that workers instead would see their earnings taxed when they put funds in. When they reached retirement and began drawing on those accounts, the distributions wouldn’t be taxed. So the plans would work more like today’s Roth IRAs — hence the term “Rothification.”
Such a move wouldn’t change tax revenue over the long run, in theory. But it would shift a lot of tax revenue from future years into the present.
And that could prove helpful from the point of view of lawmakers trying to cobble together a tax reform plan that balances in a 10-year timeline. Rothification could pull a lot of tax revenue from the future into the budget “window” that is critical in legislating.
Congress’ own Joint Committee on Taxation estimates that over the next five years, the Treasury will lose out on $583.6 billion in revenue through tax-privileged defined-contribution plans.
That is a major resource that could be dedicated to lowering tax rates, from the perspective of Republicans who have to find trillions of dollars to offset the major tax rate reductions they are aiming for.
If Republicans tried to grab it, though, they would face a lot of resistance.
First, businesses and the retirement planning industry would be at the forefront of that resistance. Many businesses are willing to back a tax bill that eliminate their preferred tax breaks in return for lower rates. But from the financial industry’s perspective, a plan to tax employees’ accounts upfront just to raise revenue on paper could be a bad target.
“We are warning the taxwriters that this could be rolling the dice on retirement security,” said Jill Hoffman, vice president of government affairs for investment management at the Financial Services Roundtable.
Tax lobbyists don’t know if retirement plans will be targeted as part of tax reform. The broad outlines of the tax plan are still being hashed out by Republican congressional leaders and the Trump administration, who plan to outline some broad areas of agreement this week. Only when the House Ways and Means Committee actually releases legislative text will businesses be able to see the exact tradeoffs they are facing.
The Trump administration has been equivocal about its view of retirement savings vehicles. At times, officials have said that 401(k)s and other plans will be left alone in tax reform. On other occasions, though, members of the administration have suggested that only the mortgage interest deduction and charitable contributions are safe.
For those wondering what a package might look like, though, 2014 provides one scenario. Then, Ways and Means Chairman Dave Camp, a Michigan Republican, released a draft tax reform bill that included major changes to retirement plans. In particular, the contribution limits for 401(k)s were cut in half, with the rest going to Roth plans. He also made other changes that would crimp workers’ ability to put pre-tax dollars into retirement accounts.
Those are the kind of changes that employers would fear. One concern is that if contributions were taxed up front, workers would see a bigger chunk taken out of their paychecks. Accordingly, they might start contributing less to retirement.
In one scenario, workers could become less interested in employer-sponsored retirement plans altogether, suggested Will Hansen, senior vice president for the ERISA Industry Committee, a group that advocates for large employers on benefits issues. “Those are all just open-end questions right now,” he said.
As with so many other provisions of the tax code, tax preferences for defined-contribution plans enjoy the support of a dedicated coalition that is ready to get to work: The Save Our Savings Coalition, made of several industry groups and large businesses.
The other source of opposition would be people concerned about the federal debt.
“If the gimmick results in a higher level of debt, then it’s harmful,” said Marc Goldwein, senior policy director for the Committee for a Responsible Federal Budget, a group that advocates for lower deficits.
The issue is that Rothification of 401(k)s would not actually raise revenue, the way that eliminating a tax credit or loophole used by business would. Instead, it would merely shift the timing of when the government received the revenue. As a result, if the tax reform plan, including the gimmick, looked on paper as though it did not add to deficits, could be a big net tax cut. In general, most members of Congress are willing to play such games. But others have resisted similar moves in writing budgets or other legislation.
And in the out years, the Treasury would see lower tax revenue, as people began withdrawing funds from retirement accounts tax-free. “What you’ve basically done is charge the cost of rate reductions to a future generation,” Goldwein said.
