As a part of his economic policies, newly sworn American President Joe Biden has proposed some major changes to the 401(k) tax plan which will have a profound impact on the tax break that 401(K) investors receive. If Joe Biden’s plan is passed as a law, the tax deduction for contributing to a 401(k) is going to be replaced with a tax credit. This 401(k) change will result in high earners getting lower tax breaks on their 401(k) savings but people belonging to low and middle income groups will end up with a higher tax benefit. Let’s find out more about the Biden 401(k) plans.
Biden 401(K): What’s Going to Happen?
What are the proposed changes to the 401(k) as per Joe Biden?
- The 401(k) tax deduction would disappear.
- Workers would instead get a tax credit for 401(k) contributions.
- The tax advantage of contributing to a 401(k) would be reduced for higher earners and increase for low and middle earners.
- Workers without access to a workplace retirement account will automatically get a 401(k) account.
- It will allow caregivers to make catch-up contributions to retirement accounts.
Biden 401(k): Will tax credit replace tax deduction?
Based on the existing tax laws, employees have the option to have a set percentage of their salary invested in a 401(k) and have the option of deferring paying tax on that till they withdraw it from the account. This tax deduction provides the greatest tax break to people with the highest incomes. For example, an employee earning $70,000 a year at the 12% tax rate can put $10,000 into a 401(k) and the tax savings would be $1,200. But a higher earner making $450,000 annually at the 35% tax rate who puts the same $10,000 in a 401(k) gets a tax break of $3,500.
Biden’s proposal would end the tax deduction for contributing to a 401(k) and replace it with a tax credit. “Biden is proposing making it an equal tax break no matter what your income level is,” says Bryan Bibbo, lead advisor at the JL Smith Group in Avon, Ohio. “The proposed tax credit is 26%, whether you are at $70,000 or $450,000.”
The Biden campaign says this 401(k) change will “equalize” the tax benefits of 401(k) plans among various groups of employees. “Biden will equalize benefits across the income scale, so working families also receive substantial tax benefits when they put money away for retirement,” according to a statement on joebiden.com.
The tax changes may also apply to 403(b) accounts for employees of nonprofit organizations, universities and government and 457 accounts for state and local government employees. “At 26%, everybody is getting the same credit,” says Matthew Schwartz, a financial advisor at Great Waters Financial in Minneapolis, Minnesota. The credit could be refundable, meaning that workers who don’t earn enough for the credit to offset their income tax liability would still receive the value.
Biden 401(k): Workers without 401(k) will get access to one
A large percentage of the American workforce doesn’t qualify for a 401(k) account because some employers don’t provide a retirement plan. The Pew Charitable Trusts found that 35% of private sector workers over age 22 work for a company that does not offer a 401(k) retirement plan. Millennials (41%) are the least likely to have access to an employer-sponsored retirement plan, but over a third (35%) of Gen Xers and 30% of baby boomers are unable to use the tax benefits of a 401(k) plan to their advantage.
What is the “Automatic 401(k)”?
The Biden administration is calling for the creation of an “automatic 401(k)” for those who don’t have access to a retirement account through their job. “There are a lot of people not able to contribute to pensions or 401k(s),” Bibbo says. “(Biden’s proposal) would create an automatic 401(k), which may be private-based or government-based. People who do not have access to a 401(k) now will have access to a 401(k) that they can contribute to and have contributions coming out of their paycheck.”
Biden 401(k): What about the caregivers?
In order to be eligible to contribute to a 401(k) plan, workers need to earn at least some income. Biden has proposed allowing caregivers to make catch-up contributions to retirement accounts, even if they are not earning a formal income.
These potential 401(k) changes that were hinted at during Joe Biden’s campaign can lead to significant changes in the tax benefits of the 401(k) plans. This will also create new retirement opportunities, especially for people without a 401(k) account right now. However, you must remember, the Biden 401(k) proposals are still in the “proposal” stage and haven’t been turned into laws. If or when they get implemented, they will be subject to change.