How President Biden’s tax proposals might have an effect on your retirement plan
By Danielle Harrison, CFP
Benjamin Franklin is often quoted for saying, “Nothing can be said to be certain except death and taxes.” What Ben Franklin failed to point out, however, was that just because taxes are safe, it doesn’t mean that they aren’t constantly changing and that they don’t present a lot of uncertainty. Our country’s tax system is a key component in how society achieves both social and economic goals. Changes in tax policy can have a profound effect on the behavior of individuals and companies.
With every presidential campaign comes a litany of proposed tax policy changes. While these are merely suggestions and may never go into effect, it is still good practice to be clear about what the pike might face. During his 2020 campaign, Joe Biden made several tax policy proposals. One of these proposals focused on the deductibility rules for retirement plans, which could have a huge impact on the way Americans save for their future.
Alignment of contributions to old-age provision
Biden’s proposal would offset the tax benefits of saving for retirement by introducing a refundable tax credit for contributions to a traditional retirement plan such as 401 (k), 403 (b), or IRA. Under the current system, contributions to a traditional retirement account are deducted from the individual’s income, effectively providing a tax benefit on the contribution equal to the applicant’s marginal tax rate. Someone in the highest current marginal tax bracket of 37% would receive a tax break of $ 37 for every $ 100 that contributed to a traditional plan, while someone in the 10% bracket would only get a tax break of $ 10 for every $ 100. The new proposal would issue an estimated 26% credit for every dollar contributed to a traditional retirement plan. Regardless of what tax bracket a person falls into, for every $ 100 they would get a benefit of $ 26.
For many, this 26% tax credit increases the tax benefits of contributing to a traditional retirement plan. This is the intent of the proposed change in the hope that this higher benefit will result in higher retirement savings. However, there are those who would not benefit from this change in tax legislation.
Those who are negatively affected by the proposal
Although the majority of the changes to the tax proposal that Biden made in the 2020 election were aimed at those with a household income greater than $ 400,000, this particular proposal could have a negative impact on those earning less than that amount. For example, someone under the age of 50 trying to maximize their traditional 401 (k) at $ 19,500 and making more than $ 331,470 (using the current marginal tax brackets) would receive a lower tax benefit than the current deduction model. The biggest tax benefit for maximizing a 401 (k) in 2021 would be capped at $ 5,070 (19,500 x 26%) for applicants under 50 and $ 6,760 (26,000 x 26%) for those over 50 who take full advantage of the catch -up posts.
In addition to reducing the tax break for individuals over certain incomes, switching from a deduction to a loan can have a big impact on many other taxpayers. Funding traditional retirement accounts has historically been a tactic to lower taxable income. People who use this lever to reduce their income would no longer have this option due to the proposed amendment to the tax code.
Lower taxable income through traditional pension contributions
Adjusted Gross Income, Modified Adjusted Gross Income, and Taxable Income are all used to determine eligibility for certain tax benefits and other income-related programs. For example, the amount received in the last round of stimulus payments is determined by a household’s Adjusted Gross Income (AGI). Individual applicants over $ 80,000 will not receive an incentive payment (and a discounted payment for an AGI over $ 75,000), and those who are married will collectively receive no incentive payment for an AGI over $ 160,000 (phasing out from $ 150,000) Dollar).
Consider the case of a couple with three children and an estimated AGI of $ 160,001. You would miss the third COVID-19 relief payment as it is just above the AGI exit limit. Currently, the couple can leverage contributions to traditional retirement accounts to realize additional tax deductions and reduce the AGI to less than $ 150,000, thereby qualifying for the total stimulus payment of $ 7,000. After the proposal discussed, such tax strategies would no longer be an option.
Below is a (not included) list of items that are dependent on household income (whether taxable, adjusted gross or modified adjusted gross):
· Tax rate on investment income
· Child tax credit
· Tax credit for children and people in need of care
· Tax credit for adoption
· Education-related deductions and tax credits
o American Opportunity Tax Credit
o Lifelong learning credit
o Tuition fee and fee deduction
o Interest deduction for student loans
· Single prints
o Doctor and dentist costs
· Health care premium grants
· Deductible IRA contributions
· Eligibility for Roth IRA contributions
· Taxable social security benefits
· Credit of the saver
· Earned Income Tax Credit
Medicare IRMAA (earnings-related monthly adjustment amount)
· Medicare surcharge
· Eligibility for loss of passive activities
· Charitable deductions
· Qualified business income deduction
This proposed amendment to the tax law has wider implications than just the tax breaks for pension contributions received by high-income workers.
When this proposed tax change becomes law, individuals should take a look at their personal situation to determine whether it is best to continue saving on a traditional retirement account. Rather than contributing to a traditional 401 (k), high-income individuals may find it more beneficial to contribute to a Roth 401 (k), if available, to take advantage of tax-free accruals and withdrawals. Individuals contributing to traditional accounts solely to lower their income in order to qualify for certain income-related benefits also want to decide whether contributing to Roth accounts instead of traditional accounts is beneficial. These taxpayers can look to other strategies to reduce taxable income, such as: For example, a contribution to an HSA (for those with a high deductible health insurance plan) or a Flexible Expense Account for Medical or Dependent Care (FSA).
About the Author: Danielle R. Harrison, MBA, CFP®, CFT-I ™
Danielle R. Harrison, MBA, CFP®, CFT-I ™, is the founder and president of Harrison Financial Planning, a mid-Missouri-based commercial financial planning firm equipped to work with clients across the country. Harrison Financial Planning provides comprehensive financial planning and investment management, helping clients with any financial decisions that arise. Harrison Financial Planning specializes in working with busy professionals and retirees who love giving back through their jobs, volunteering, or charitable giving.