How Tax Reform Could Affect Your Retirement Strategy

It’s Year One with a new political administration and change is inevitable. While economic changes and tax reform discussions are taking place on the hill and in the White House, many people want to know, How does this affect me directly?

The most recent iteration of tax reform released by the current administration vows for significant cuts to the following, among others:

  1. Estate tax. Families who were in a high enough income bracket have long had to pay an estate tax, or taxes on assets they’ve inherited upon the passing of a family member. Under new the new reforms proposed, this tax would be eliminated entirely. The proposal has been criticized for only positively affecting “5,000 of the wealthiest inheritors every year.”
  2. Alternative minimum tax. Originally intended to be a tax on the super-wealthy, but ending up being a tax they’re able to avoid, passing on to the middle class, the alternative minimum tax (AMT) would be eliminated under new reforms. However, this also may mean a cap on deductions, so middle class wage-earners with a long deductions list could end up paying more.
  3. Four income tax rates. Presently, there are seven different income tax brackets, with the top tier being taxed at 39.6% and the bottom tier at 10%. Under new reform proposals, three brackets would be eliminated, to include the top tier bracket. This would mean that the new top tier bracket would be taxed at 35% (down from 39.6%) and the bottom tier would stay the same, with the middle at 25%. Earners in the current high bracket would see a significant reduction in their tax rate.
  4. Federal income tax rate for corporations, small businesses, and partnerships. This tax rate would be reduced to only 15% under the new plan, across the board, no matter what revenue is brought in. There would also be a one-time-only tax on US companies with overseas presence in addition to the new tax rate, as a “penalty” of sorts for non-domestic business activity.

So how does all of this affect your strategy in terms of planning for retirement?

  • Savings benefits may not feel as robust as they once did. When tax rates decrease, the savings one gets from a retirement plan may not feel as great as before. In the past, these savings have been something that can be socked away with maximum impact since assets are only taxed on withdrawal. Because these retirement accounts may begin looking less like pretax dollars and more like Roth accounts (see below), the impact felt could be lessened.
  • 401(k) and other retirement accounts could look more like Roth. 401(k) accounts, along with other retirement accounts, have always been funded with pretax dollars, as mentioned above. With the changes that could be implemented with new tax reform proposal, there would be a huge reduction in tax deduction opportunities. Without these deductions, 401(k) accounts could end up being funded like a Roth account, with after-tax dollars (so you’re saving less) but also allowing to be withdrawn tax-free (which can feel good when you need to take that money out.)
  • Federal employees may see dramatic cost increases in retirement savings. Reforms propose trying to make private sector retirement savings plans more aligned with federal retirement savings plans…but not by making one less expensive. Instead, there would be a plan to share the cost of contribution in order to make private sector plans more profitable, and that shared cost would–as it currently stands–fall on federal employees to make up.
  • Employer-funded plans may change, but it’s not likely. Most employers currently allow employees to contribute to an employer-matched retirement plan with pre-tax dollars, most often diverted into a 401(k) account. If reforms happen the way the administration has them presently outlined, these accounts, as mentioned above, will change to a post-tax contribution. While this may dissuade some employers from these plans, recent survey results suggest it would be fewer than 10% of employers that would not want to continue with this type of retirement account.

Right now, the current administration’s proposals for tax reform are being considered more “suggestions” than “policy,” according to lawmakers. It is important to note that the proposals in their current state may seem confusing; it is going to take some serious conversation with lawmakers to flesh out exactly how tax reform will impact retirement savings and when that will take place. There is, at the moment, no cause for concern or immediate strategy changes when it comes to retirement plans–while that could happen down the road, right now, it’s just important to be aware of what’s happening in the conversation.

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Written by Danielle Bilbruck

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