With the election in full swing, it is important to understand how the election of either candidate could affect your retirement savings and taxable income. Biden’s new tax plan, which was just unveiled via his website, calls for reforms of 401(k) tax breaks. This would be a break away from the established tax breaks that typically favor higher income families. With a potential restructuring of the 401(k), many are looking if there is any other account that would be a more tax favorable investment for their retirement savings.
Under the current framework of the 401(k), contributions you make are considered as pretax dollars, meaning the money you contribute will help lower your taxable income. Under the existing rules, the higher your tax bracket, the more savings you are accruing on your taxes. Therefore, this method of 401(k) tax breaks favors those who have higher income salaries. Those who are in lower tax brackets experience less benefits from investing in a 401(k). The equalization of 401(k) benefits is the main purpose of Biden’s proposed changes.
The main difference in Biden’s plan lies in the deduction savings of the 401(k). Instead of pretax dollars being used to lower your taxable income, Biden aims to give a sweeping 26% credit to your taxed income. Contributions to your 401(k) would no longer be considered tax exempt. This disproportionately harms higher income salary earners because their salaries will be subjected to more taxes such as income tax, which would be more beneficial for the working- and middle-class families who would earn a higher credit under Biden’s plan. The reform to the 401(k) is seen by many financial advisors as Biden’s attempt to redistribute wealth and disproportionately favor working class families. However, it is still ultimately up to interpretation as the reforms have not been fully structured.
With all contributions to your 401(k) now falling under taxable income, investors are looking to see if there is a better account to place their income in. Those who are enjoying the high income benefits of the 401(k) might now turn to Roth IRA’s. Roth accounts allow users to put taxed income into these accounts and they grow tax free. Since all income will now be taxed before contribution, it may make sense for people to take advantage of the Roth’s ability to grow money without worrying about accumulating taxes. However, this could be problematic for those who make too much to qualify for Roth IRA contributions. Under this alternate savings option, people will make contributions to a traditional IRA account that are not tax deductible and do a backdoor conversion to a Roth IRA.
Ultimately, Biden’s plan to change tax benefits for 401(k)’s is not hostile for high-income earners. He aims to limit the amount of benefits that can be gained under the current framework, not revoke benefits all together. It is advisable that everyone accesses their saving options any time changes could be proposed to savings accounts. Any change despite how small could have big impacts on your taxes and future retirement plans.
At Wolfe Financial, we are committed to providing expert guidance towards well informed financial decisions. Call us today at 301-652-9677 and learn how we can help you find the next step along your financial journey.
Sources:
https://www.cnbc.com/2020/09/22/biden-calls-for-401k-tax-break-overhaul-what-it-means-for-you.html