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It’s been a week of confusing messages about whether Congress will look to place a $2,400 cap on the amount of pretax contributions American workers can put in their 401(k)s.
President Trump said in an Oct. 23 tweet that there would be no change to 401(k)s, but Republican leaders have continued to say “everything is on the table” as part of tax reform.
There’s been a quick response by many in the retirement industry who say any attempt to cap pretax contributions at $2,400 would severely weaken U.S. workers’ retirement savings and readiness.
If the tax deduction for 401(k)s is capped at $2,400, that limit “could be viewed by plan participants as a signal as to how much they should contribute to their plan,” Jack VanDerhei, research director at the Employee Benefit Research Institute, said Oct. 20. He was speaking during a U.S. Chamber of Commerce forum on retirement savings.
Employees typically want to receive the maximum matching contribution from their employer, and they set their 401(k) contributions in a way to ensure they get that match, Dave Gray, senior vice president, retirement product leader, for Fidelity Investments, said during the Chamber forum.
“Most people don’t have enough money saved now, and this cap will likely keep them from caching up to a level where they will have enough to live on in retirement,” Diane Oakley, executive director of the National Institute on Retirement Security, told Bloomberg BNA Oct. 24.
If employees view the $2,400 contribution cap as advice from the government on how much to contribute to their plan, there would be a drastic reduction in the amount the average participant contributes to their plan. The average participant in a 401(k) plans serviced by Fidelity contributes $6,500 per year, with 70 percent of participants contributing more than $2,400, Gray said.
Across all age groups and income levels, the average full-time worker contributes more than $2,400 annually to their 401(k) plan, according to research from EBRI.
Even for low income employees, about a third or more of those making between $10,000 and $50,000 per year on average make contributions in excess of $2,700 annually, EBRI said. For employees earning more than $50,000 per year, a clear majority contribute on average more than $4,000 annually, EBRI said.
If 401(k)s are still being targeted, some believe that a cap on their deductibility will serve to undermine the idea that tax cuts are to benefit the middle class and grow the economy.
Roth accounts (those that are taxed when contributions are made rather than at retirement) favor higher income earners who can afford to make larger contributions and who will be able receive the money tax-free later in life, Oakley said.
The average annual contribution for those earning more than $100,000 per year is over $11,000, while it is about $3,200 for those earning between $10,000 and $25,000, according to EBRI.
The cap will also help ensure that retirees have less money to spend once they stop working, which will help slow the economy down the road, Oakley said.
There’s also a fear that participants could end up using Roth accounts as a “virtual piggy bank,” Aron Szapiro, director of public policy research with Morningstar Inc. in Chicago, said during the Chamber forum. Under current law, Roth contributions can be withdrawn tax free at any time.
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