Could Employer Retirement Accounts Change in a Biden Administration?

There’s talk that tax-deferred retirement plans could be replaced by a system based on tax credits.

Everyone wants to know what changes we can expect with an incoming President Biden. One area Biden has expressed interest in on the campaign trail is updating the country’s 401(k) retirement plans. According to Investopedia, 401(k)s are currently the most popular type of employer-sponsored retirement plan in the United States.

A 401(k) is eligible for special tax benefits under Internal Revenue Service guidelines. Employees can invest a portion of their salary up to an annual limit. Employers may or may not match some part of employees’ contributions.

For 2021, the basic salary deferral limit for 401(k) and similar workplace plans remains flat at $19,500; the $6,500 catch-up amount for those 50 or older also remains the same, but the overall limit for these plans goes up from $57,000 to $58,000 in 2021, to include employer contributions. The overall limit helps employees whose employers allow special after-tax salary deferrals.

Biden’s Proposal

While Biden’s retirement plan would not end 401(k) accounts, it would flip the incentive structure of a retirement system based on deducting retirement savings from payroll taxes.

According to Forbes magazine, Biden’s basic proposal is to repeal the tax deferral offered for traditional retirement plans, such as 401(k)s and individual retirement accounts, replacing it with a tax credit.

Biden’s campaign website said that this action would equalize retirement saving tax breaks. The concern is that high earners get higher tax advantages than most people and Biden’s hope is to provide benefits equally to all income groups.

For example, with a current 401(k), someone making $600,000 in the 37 percent bracket would get a $370 tax break for each $1,000 she or he contributes to a 401(k) plan. Someone earning $60,000 in the 22 percent bracket would only receive a $220 tax break for that same $1,000 contribution.

Under Biden’s plan, when a $1,000 contribution is made, a person earning $600,000 would get the same $260 tax break as someone making $60,000. The credit would be refundable, so an employee who earns too little for the credit to fully offset their income tax liability would still get the full tax credit.

The idea may remain an idea or be scaled back depending on what a Republican-controlled Senate will approve.

What the Critics Say

There is concern about what a drastic change like this might do to a system that’s been in place since the early 1980s. The retirement industry has long been against reform.

Industry groups representing workplace savings plan providers, mutual funds and other investment assets are interested in seeing studies. Some worry that richer households might save less, while those in favor of the tax credit say that the wealthy would save roughly the same amounts with or without the tax break.

Plus, lower-income earners might not gain that much more in their saving plans. The last study that was done on the impact of a tax credit on different income groups was in 2012. The Urban-Brookings Tax Policy Center estimated that the tax benefits would be enjoyed the most by the bottom 90 percent of households based on income, with tax increases falling disproportionately on the top 10 percent of earners. However, since the tax code and economic conditions have changed substantially since 2012, a new estimate is needed.

In addition, many lower-income individuals are living paycheck to paycheck and may not be interested in saving for retirement – regardless of the tax deferral benefit.

If this plan was put into practice, experts expect that some investors might forgo contributing to a traditional pre-tax 401(k) and receive the government contribution and instead switch to a Roth 401(k). With a Roth, the contributions are taxed upfront but funds built up over decades can be withdrawn tax-free in retirement.

One thing to consider with a Roth is that lower rates today make a Roth plan more attractive, because an investor is paying current rates in order to avoid paying higher rates when they retire. In contrast, higher rates today make the traditional 401(k) a more interesting option. Younger employees might be most interested in a Roth account because they currently are in lower tax brackets and have more years for their investment to increase.

Plans to overhaul tax deferrals have been tried before. In 2017, the House Republicans proposed to limit 401(k) plan deferrals to $2,400 annually, with any excess savings directed into Roth-style after-tax accounts. Both President Donald Trump and Democrats opposed the plan saying that it was a tax increase on middle-class savers.