Big money managers, already on guard to protect one of their richest sources of assets, are on alert as more details emerge on how prized 401(k) contributions could fall victim to President Donald Trump’s tax overhaul plan.
The New York Times reported Friday that the administration may seek to limit pretax contributions to 401(k) plans to as little as $2,400 annually, down from the current maximum of $18,000 for most workers and $24,000 for those 50 years or older.
The measure, rumored for months as a way to help offset the individual and corporate tax cuts that the Trump administration hopes to enact by year end, would essentially pull future tax revenues forward by requiring Americans to pay taxes on retirement savings now instead of when they tap their nest eggs.
Wall Street has been girding for possible changes to the lucrative 401(k) industry, which in recent decades has funneled trillions of pretax dollars from workers’ paychecks into stocks, bonds and other financial assets. As of June 30, 401(k) plans held an estimated $5.1 trillion. Giant asset managers such as Vanguard Group and Fidelity Investments fear that cutting 401(k) tax deferrals to just $2,400 a year would reduce the American public’s notoriously low savings rate even more, jeopardizing their retirement income.
“It would marginalize a key incentive for Americans to save, particularly among low- and middle-income workers,” said Dave Gray, a retirement product leader at Fidelity. The company is the largest provider of 401(k) plans, with some $1.7 trillion under administration or about 25% of the total market. “They will want to preserve take-home pay, which means they are likely to contribute less to a 401(k) and as a result might get less match dollars from their employers,” Gray said.
Similarly, Laura Edling, a spokeswoman for Vanguard, said in an emailed statement that the company is “greatly concerned over any legislation that would negatively impact investors’ ability or incentive to save for retirement. The 401(k) plan is the cornerstone of the future retirement security of millions of Americans.”
In a traditional 401(k) plan or individual retirement account, people can sock away pretax dollars that continue to grow tax-free until withdrawing the money at retirement. That set-up is seen as favorable to those who expect to be in a lower tax bracket once they retire from full-time work. In contrast, the “Rothification” of 401(k) plans would require people to fund their retirement accounts with after-tax earnings, while allowing them to withdraw the money tax-free later on.
“Members are developing pro-growth tax reform policies that will encourage and support retirement savings for all Americans,” Emily Schillinger, Republican communications director for the tax-writing House Ways and Means Committee, said in an email when asked for comment on a possible change to 401(k) parameters.
As a middle ground, allowing people to contribute the first $9,000 annually to a 401(k) on a pretax basis would protect most lower- and middle-income workers, while raising about $100 billion in revenue for the government over 10 years, according to Fidelity, which serves more than 25 million Americans through its workplace retirement plans. Lower- and middle-income workers who contribute more than $2,400 each year toss in an average of $4,900 annually to their 401(k) or other retirement plans.
“We do understand that Congress might be looking for some revenue-raisers for the tax-reform package,” Gray said. But “we think the better approach than full Rothification is a partial Roth system combined with other enhancements. ”
Having made tax cuts the centerpiece of his legislative agenda, Trump issued a broad framework in September that, among other things, called for a reduction in the corporate income tax rate to 20% from the current 35%. His initiative got a big boost on Thursday when the Senate narrowly approved a budget resolution that will enable Senate Republicans to pass a tax bill with a simple majority in the 100-seat chamber.
Now Republican lawmakers are under pressure to actually draw up the details of the tax plan and pass the legislation by year-end. They must also come up with ways to pay for the tax reduction, or risk losing support from deficit hawks within the party. The plan must also avoid adding to the long-term budget deficit; without that, its changes would have to expire. Reducing pretax 401(k) contributions has long been rumored as one option for offsetting the tax cuts.
“Clearly they are going to have to do something to create some immediate revenue,” said James Jones, a former Democratic congressman from Oklahoma who spent 12 years on House Ways and Means. “Otherwise it would blow the deficit so sky-high that it would create an economic backlash.”
In April, the Investment Company Institute—a trade group for money managers that offer registered funds—teamed up with the American Retirement Association and the Employee Benefits Research Institute, among others, to form the Save Our Savings coalition.
The group describes its mission as “protecting Americans’ retirements savings as Congress plans a comprehensive tax overhaul.” It says 80% of households with retirement accounts say favorable tax treatment is a big incentive to contribute.
A group of 16 Democratic Congressman sent a letter on Sept. 26 to top Republicans, including House Speaker Paul Ryan and Treasury Secretary Steven Mnuchin, saying they’d “heard of proposals that would mandate” the use of after-tax Roth accounts for retirement savings and partly or completely eliminate “the traditional, tax-deferred treatment of 401(k)” contributions. The letter warned that some Americans “may stop saving altogether” if forced to use Roth accounts, while others who choose to continue saving would see a “material reduction in their take-home pay.”
Five Democratic Senators sent a similar letter on Sept. 14 to Senator Majority Leader Mitch McConnell, White House economic adviser Gary Cohn, and others. The lawmakers termed mandating Roth savings a “sham” and a budget gimmick.
Details on Republican plans to revise 401(k)s have been scant. The New York Times said its report was based on interviews with lobbyists, tax consultants and congressional Democrats it didn’t name. That raises the possibility that those hostile to the idea are leaking details in an effort to raise an outcry before Republican lawmakers finish drafting the tax overhaul.
“It could either be coming from the administration as a leak, or from the special interest groups as a leak,” said Jones, who now serves as chairman of Monarch Global Strategies, a consulting firm in Washington. “One is to see what the reaction is and the other is to build opposition.”