GOP Proposes Radical Change to 401(k) System

The Republican blueprint for tax reform eliminates all itemized deductions, except deductions for mortgage interest and charitable donations.

The blueprint does not give specific changes to the tax treatment of retirement plans, but does pledge to “continue tax incentives for retirement savings,” and says the House Ways and Means Committee will develop “options for an effective and efficient overall approach to retirement savings.”

“The language suggests they are going to protect deferral limits in accounts, but it doesn’t say they won’t change how deferrals are taxed,” noted Hansen.

Congressional Republicans have also proposed the creation of Universal Savings Accounts, which would be modeled on retirement savings accounts as a way to create tax incentives to save. But those accounts would allow individuals to withdraw contributions, and investment earnings, at any time, for any reason, and without a penalty.

In 2014, Rep. Dave Camp, R-Mich., then chairman of the Ways and Means Committee, introduced tax reform legislation that would have limited pretax contributions to 401(k)s to half the annual contribution limit. The remainder of an individual’s contributions could be made on an after-tax basis.

But even with that early indication, Hansen says industry, and Congress, are flying blindly as to how Camp’s proposal, and the more aggressive idea of shifting all contributions to an after-tax basis, would impact savings rates.

“I don’t think anyone has closely examined what a massive swing to an all-Roth system would mean, and without that we should be very concerned if Congress is willing to do as much just to raise money,” said Hansen.

So far, it’s unclear if Congress is considering taxing employers’ contributions. Even if that were spared, employers would still see increased payroll tax exposure.

That reality would be enough for employers to reconsider offering 401(k) plans, particularly in the small plan market.

“In the small plan market, business owners are typically doing all the work it takes to run a 401(k) plan themselves,” said Adam Pozek, co-founder of DWC ERISA Consultants, a St. Paul, Minnesota-based third-party administrator. “Offering a plan is primarily a business-owner tax benefit.”

An added complexity to the prospect of shifting all retirement plan contributions to an after-tax basis is the role of Health Savings Accounts, a cornerstone of Republicans’ health care reform hopes.

Increased pretax limits on HSAs, coupled with new Universal Savings Accounts, could further sour employers on 401(k) plans, says Pozek.

“From a policy standpoint, it makes more sense to encourage employers to offer 401(k) plans,” said Pozek. “We know that people are 15 times more likely to save for retirement when they have access to a plan through work. If you take away employers’ incentive to offer a plan, you’re taking away access to savings options.”