Possible 401(k) tax benefit reductionIt's bad enough the stock market has been beating up on most of our 401(k)s lately. Now, legislators and big thinkers are debating a variety of proposals to reduce the tax benefits of saving in 401(k)-type plans.

One idea being floated would take away the immediate tax deduction you get for your contributions. So if you make $50,000 a year and contribute $5,000 to your 401(k), you'd no longer have the pleasure of seeing your taxable income drop to $45,000.

Right now, Americans are typically taxed once on dedicated retirement accounts: Either you contribute pretax income and don't pay taxes until you take the cash out -- as with your 401(k), for example -- or you pay in with your post-tax income, but the money that you withdraw at retirement is tax free -- as with a Roth IRA. Under this new scenario, those 401(k) investments could be taxed both before and after taxes, just like your regular investments.

But some things may be sacred. There's not a high probability that you'll have to pay taxes on your profits any sooner than you do right now. Say you have $100,000 in your 401(k) and you make $5,000 in capital gains on it. As it stands now, you wouldn't get taxed on that $5,000 until you withdraw it, and there's not much chatter that anybody is looking to change that.

So who has the most to lose from the proposals being debated? Low-income workers, says the nonpartisan, nonprofit Employee Benefit Research Institute, because they're the ones most likely to respond to a loss of the tax break by either cutting their contributions or stopping them altogether.

A Major Disincentive to Save for Retirement


At a recent hearing of the Senate Finance Committee, EBRI Research Director Jack VanDerhei, explained the potential impact.

"As expected, the highest-income workers generally would be the most affected if federal tax limits in 401(k) type plans were lowered," VanDerhei said in a prepared statement. "But the surprising result we found is that the lowest-income workers would also be very negatively affected, and many report that they would reduce contributions or stop saving in their work-based retirement plan entirely, if the current exclusion of worker contributions for retirement savings plans were ended."

For instance, VanDerhei said that if workers lost their deduction in 2012 and saw it replaced with flat-rate tax credits -- as was recently proposed by Brookings Institution Fellow William Gale -- the average reductions in 401(k) accounts at normal retirement age would range from a low of 11.2% for employees now ages 26-35 in the highest-income groups, to a high of 24.2% for employees in that age range in the lowest-income group.

At the hearing, Gale explained his proposal to "reform public policies toward retirement saving by replacing the current deduction for contributions to retirement saving accounts with a flat-rate refundable credit that would be deposited directly into the saver's account. The proposal would (a) address long-standing concerns in the retirement saving system by improving incentives for most households to participate and by raising national saving, (b) offset pressures created by the current weak economy for households to reduce their retirement saving, (c) help solve the long- term fiscal problem facing the country by raising $450 billion over the next decade in a manner that is consistent with the principles of broad-based tax reform and distributes the fiscal burden in a progressive manner."

Earlier EBRI analysis of the bipartisan deficit commission's other proposal to reduce the 401(k) savings caps to either $20,000 a year or 20% of income (the so-called "20/20 cap") starting in 2012, would most affect the highest-income workers -- not surprising, since those who earn more tend to save more using these kinds of retirement plans. However, EBRI also found the cap would cause a big reduction in retirement savings by the lowest-income workers as well. Today, the annual cap is $16,500, with an extra $5,000 allowed for those who are 50 and older.

Would Employers Drop 401(k) Plans?


All the proposed monkeying around with retirement savings plans could be one more nail in the retirement coffin. After all, the number often bandied about for how much money the average American will have at retirement is around $50,000 -- hardly enough to live the glamorous life in one's golden years.

VanDerhei told DailyFinance he's worried the Brookings proposal might find some support in Congress. "It promises to save the government $450 billion over 10 years, which could look attractive to the [Supercommittee that] is tasked with coming up with a lot of savings between now and Nov. 23."

Gale is leading the charge to make employers' contributions taxable and for employees to lose their 401(k) deduction. Instead, he suggests a flat-rate refundable credit of either 18% or 30% that would serve as a matching contribution to a retirement savings account. VanDerhei says this would surely diminish some employers' willingness to offer 401(k) plans, as well as employees' desire to participate in them.

Said VanDerhei, in a prepared statement, "Given that the financial fate of future generations of retirees appears to be so strongly tied to whether they are eligible to participate in employer-sponsored retirement plans, the logic of modifying (either completely or marginally) the incentive structure of workers and/or employers to save in a defined contribution plan needs to be thoroughly examined."

VanDerhei says it's not a stretch to think that too much tinkering could lead to some companies shutting 401(k) plans down. The consequences would be huge. "When people don't have 401(k)s, they often don't save elsewhere for retirement. Anything that will cause a drastic reduction in retirement savings at a time when there are various proposals to decrease Social Security benefits, makes it hard to see how people will have any standard of dignity in retirement."






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vinnyo

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October 12 2011 at 3:18 PM Report abuse rate up rate down Reply
Renata

Google for "deflationary crash and pension plan" to understand the threat to your retirement.

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--------I think they really need to get rid of the 'big thinkers' and clowns in finance that come up with these so-called solutions to the screwing of the poor and middle class....a complete revamping of ALL of them is needed...not news way to screw us over to cover their behinds....if they keep coming up with solutions like these...everyone will be leaving the U.S soon...then they'll have nobody to steal money from BUT themselves...

September 28 2011 at 4:19 AM Report abuse rate up rate down Reply
Bianca

Anything that will cause a drastic reduction in retirement savings at a time when there are various proposals to decrease Social Security benefits... exactly !http://www.voyagesauperou.net

September 27 2011 at 12:06 PM Report abuse rate up rate down Reply
some12bo

401k is not a good idea anymore. Government can find ways to confiscate your savings, simplest being taxation when you withdraw. Tax rates can be higher when you retire. Google for "deflationary crash and pension plan" to understand the threat to your retirement.

September 26 2011 at 11:33 PM Report abuse rate up rate down Reply
msollenne

I think they really need to get rid of the 'big thinkers' and clowns in finance that come up with these so-called solutions to the screwing of the poor and middle class....a complete revamping of ALL of them is needed...not news way to screw us over to cover their behinds....if they keep coming up with solutions like these...everyone will be leaving the U.S soon...then they'll have nobody to steal money from BUT themselves...

September 23 2011 at 2:12 PM Report abuse rate up rate down Reply
Gary

You know it never ceases to amaze me. William Gale of the Brookings Institution proposal promises to "save" the government $450 Billion over 10 years. What he really means is increased taxes of $450 Billion over 10 years. If he wanted to deal with saving the government $450 Billion over 10 years he should be looking for ways to reduce spending.

September 23 2011 at 1:23 PM Report abuse rate up rate down Reply
1 reply to Gary's comment
MONTOOTH

Or look for a way to collect on the 350 billion dollars in unpaid taxes by Americans who do not pay.

September 24 2011 at 1:25 AM Report abuse rate up rate down Reply
jkosters

We are stuck buying into funds going long and they get to go short. A few years ago you could look into these hedge funds online, try and find any info now. If you had a minimum of $1,000,000.00 you could buy into some of them in the mid 90's. Then you see the crash in 2000 and several since where we were stuck going long in our 401k's while they went short. What nice deal for them to control the media and our savings. CGMFX at least allowed me to be able to short Countrywide in 2007 for a 70% gain. I think the easiest way to make money in the market is shorting it. Going long hasn't worked. Ponsi scheme keeps ringing in my ears.

September 23 2011 at 10:37 AM Report abuse rate up rate down Reply
rcohn95038

Ghis entire story sounds like just one more way Washington would raise more mmoeny from the citizens to waste, just like they are doing with most of the exorvbitant amount of money they already raise, and waste. Insted of wanting more money, they need to cut the size of our government tremendously. Any business person could cut the size of government without problem, without scrificing the function of it.

September 23 2011 at 9:10 AM Report abuse rate up rate down Reply
ccurt78

First, they sold everyone on the value of a 401k, which have experienced many losses over the years. Lack of oversite allowed the rating agencies to fraudulently rate junk stock as as a1. Net result was major loss to individual accounts.How long are we the people going to continue to be sheep ! Don,t just read and comment on these sites, contact your politician and raise hell, threaten and or vote the person out, make your voice heard.

September 23 2011 at 7:44 AM Report abuse rate up rate down Reply