Your 401(k) retirement tax break

Right now, workers can put up to $18,000 a year in a 401(k) retirement account, and another $6,000 if they’re 50 or older, bringing the total to $24,000. Those savings are made pre-tax, so they instantly drop a retirement saver’s income, and thus tax bill, in the eyes of the IRS. Money in a 401(k) is taxed only when it’s withdrawn from the account, possibly decades later.

Congress is exploring changes to the rules that would push workers to make more of their contributions to post-tax accounts, also known as Roth 401(k)s, from which money isn’t taxed when it’s withdrawn. For Congress, moving from traditional to Roth would bring in more money in the short term, even if it robs the Treasury of tax revenue later.
Workers would almost certainly notice the change.

For someone earning $200,000 or more and making the maximum possible contribution—as they should if they hope to keep up their standard of living in retirement—a traditional 401(k) cuts taxes owed by more than $8,000 a year.  Even someone making $100,000 and saving half the maximum amount in a traditional 401(k) is lowering his or her tax bill by almost $3,000 a year. (To keep things simple, our taxpayers are single and childless, but these tax breaks can be just as valuable to couples and families.)

The possible “Rothification” of 401(k)s is worrying many retirement experts, along with the financial firms that manage that money.

“Comprehensive tax reform has the potential to be one of the biggest threats to our retirement system, in a way that ruins our incentives to save,” said Bradford Campbell, a partner at the law firm Drinker Biddle & Reath LLP who served in the U.S. Department of Labor overseeing employee benefits under former President George W. Bush.

Overall, tax breaks for 401(k)s and other workplace defined-contribution plans cost the U.S. government $102 billion this year, according to the Joint Committee on Taxation, a nonpartisan congressional research group. The number is expected to rise to $146 billion by 2020.

Your state and local taxes

Tax expert Robert Willens, of New York-based Robert Willens LLC, said an area of “huge concern” for his clients is the possibility that the deduction for state and local taxes, or SALT, will go away. In a high-tax locality like New York, a client making $1 million may end up paying $120,000 in state and local taxes, he said. By deducting those taxes on a 1040 return, the client might avoid $48,000 in federal taxes. If Congress kills the SALT, as the Trump administration has proposed, “that’s a massive tax increase,” Willens said.

The SALT will cost the government $69 billion this year, the Joint Committee on Taxation estimates. It saves lots of money for our hypothetical taxpayers, who we assume live in highly taxed California.