Journalists Are Still Getting Biden’s Tax Plan — And 401(k) Taxation — Wrong
It seems that my crusade to educate readers on the Biden 401(k) plan (and, yes, others’ reporting on the subject) has not gone unnoticed. But have those reporting on it truly studied up on how Biden’s plan would work or, more importantly, how 401(k) plans and 401(k) taxes work, generally speaking? Do they, in other words, merit the Jane the Actuary Seal of Approval?
Remember: the two tax benefits of a traditional 401(k)/IRA are the fact that (1) investment earnings are not taxed and (2) taxes are paid based on total effective tax rates at retirement rather than one’s current marginal (top) tax rate. For Roth plans, the investment-income exemption is paired with the ability to “lock in” your current marginal rate if you expect it to be higher in the future (if you expect to earn more in the future or expect the government to hike taxes). (See “A Refresher Course On 401(k) and IRA Tax Benefits – For Joe Biden’s Advisors, Too.”)
Joe Biden’s plan, on the other hand, would replace this favorable tax treatment with a government-provided “match.” The details are somewhat murky but appear to involve double-taxation (after-tax contributions which are taxed again as ordinary income when withdrawn) which would nonetheless benefit lower-income savers if the “credit” is higher than the tax they’d pay, but would cause higher earners to move into Roth accounts. (See “Joe Biden Promises To End Traditional 401(k)-Style Retirement Savings Tax Benefits. What’s That Mean?” and “Confused About Biden’s Tax Plan For Retirement Savings? An Actuary-Splainer About 401(k) Taxation.”)
That being said, let’s look at some recent reporting:
Catherine Brock, The Motley Fool, September 14, 2020, “Will Biden’s Proposed Changes to 401(k) Tax Rules Affect Your Retirement Plan?”
Jane the Actuary Seal of Approval? Not even close!
“To understand what that means, it helps to revisit how those tax benefits work today. Under current rules, your 401(k) contributions are made with tax-free dollars. The amount you save by not having to pay taxes on those contributions is dependent on your tax bracket. If you are in the 22% tax bracket, you save $0.22 for every $1 you contribute. But if your marginal tax rate is 37%, you save $0.37 for each $1 contributed.”
No, no, no. The tax collector will indeed come for that money, just not now.
When one deducts charitable contributions, for example, from one’s taxes, it is a “true” deduction. But a 401(k) plan is entirely different, because it’s a tax deferral rather than a deduction.
Brett Arends, MarketWatch, Sept. 15, 2020, “Will Biden’s 401(k) plan help you or hurt you?”
Jane the Actuary Seal of Approval? Trying harder, at least.
“Right now you can deduct your contributions to your 401(k) plan right off the top of your income. So far as the IRS is concerned, the money is invisible for this year’s calculations. Make $200,000 and contribute the maximum $19,500 to your 401(k), and as far as Uncle Sam (and your state) are concerned, you didn’t make $200,000 this year, you only made $181,500.
“The more tax you pay, the more this saves you. If you have to pay the top, 37% federal tax rate on every extra dollar you earn, deducting that money from your tax return saves you $7,215 in income taxes. But if you’re only paying 10% federal tax on each extra dollar you earn, deducting $19,500 would save you just $1,950.”
The phrase “invisible for this year’s calculations” gave me hope that Arends would address the fact that the taxes are indeed paid at the back end, but no such luck, though he does acknowledge that “In practice, of course, most of those would simply get around the maneuver by changing their contributions from ‘traditional’ to ‘Roth.’”
Alicia Munnell, MarketWatch, September 14, 2020, “Biden’s 401(k) plan: Changing tax incentive for retirement is a great idea.”
Munnell is the director of the Center for Retirement Research at Boston College, so she knows her stuff. But does she communicate it to an audience that doesn’t?
Jane the Actuary Seal of Approval? Still falling short.
“Employers and individuals take an immediate deduction for contributions to retirement plans and participants pay no tax on investment returns until benefits are paid out in retirement. . . .
“If a single earner in the top income-tax bracket contributes $1,000, he saves $370 in taxes. For a single earner in the 12% tax bracket, that $1,000 deduction is worth only $120.”
Ugh. Again, taxes on contributions are deferred in a manner that has the effect of eliminating taxes on those investment earnings. A top-bracket earner doesn’t “save $370”; he defers that taxation and saves the investment return-taxes plus whatever amount the future taxes are lessened due to lower income in retirement.
Munnell does then, quite helpfully, cite research which, if its conclusions are borne out by other data, shows that tax incentives have no significant effect on retirement savings, but that auto-enrollment and other means of making saving automatic have a much larger effect. Whether her desire to make this larger point within a constricted word limit lead to her choices in explaining 401(k)s, I can’t say.
Timothy Carney, Washington Examiner, September 14, 2020, “Joe Biden won’t admit it, but his proposal would hike taxes on the middle class.”
Jane the Actuary Seal of Approval? Yes, then no.
“Under current law, income you put in your 401(k) retirement account today doesn’t get taxed until you can actually touch it— which is at retirement, at 59 and a half years old. It’s not a tax deduction like the deductions you get for health insurance and mortgage interest, as much as it’s a tax deferral. You will pay taxes on that income, but not until you get your hands on it and can spend it.”
So far, so good. But then Carney works out some math to prove that even average earners would be hurt under the Biden proposal, and he flubs it, comparing the value of the potential tax credit to the lost benefit of the tax deferral, but calculating it as if it were a true deduction instead.
So there you have it. Readers, if you come across similar reporting — or one that would actually merit the “Seal of Approval” — send it my way, along with your comments at JaneTheActuary.com!