Current Thinking

US Tax Reform and Retirement Savings – Should the Two be Related

When considering a topic as broad and politically charged as Tax Reform, there are two major issues to consider when gauging its impact on retirement: structural changes in the tax code; and the impact of tax changes on the budget deficit-who will pay for the changes when they are expected to reduce revenue?

The tax reform proposals put forth by the Trump administration would reduce the number of personal tax brackets, lower the corporate tax rate to 15%, eliminate the Alternative Minimum Tax (AMT) and keep the capital gains tax brackets on investments at current levels (20%, 15% and 0%).1 On its surface, there should be relatively little impact of these proposals on the economics of retirement savings. Tax deferral via defined benefit plans and 401(k) provides a superior means of accumulating wealth for retirement. Any changes in savings should be marginal (e.g. use of traditional versus Roth 401(k)s). Individuals in the highest tax bracket who see their tax rates lowered may have the benefit of tax deferred savings slightly reduced in the near term, although this benefit would be reversed should tax rates increase in subsequent years.

However, there have been ideas floated by the Congressional Budget Office (CBO) and Congress to tap retirement plans to fund shortfalls projected from reductions in tax revenue. One recent scenario analysis by the CBO would lower the maximum allowable employee 401(k) annual contribution from $18,000 to $16,000 and would eliminate the over 50 catchup provision.2 While the difference seems small, a $2,000 reduction compounded annually over 30 years could potentially lead to a loss of nearly $133,000 in earnings for retirement. For individuals over 50 years of age, a total reduction of $8,000 annually could lead to a loss of nearly $173,000 in retirement earnings over a 15-year horizon.3

Many in the retirement industry believe that a major policy initiative such as tax reform should be kept as separate as possible from retirement savings policy, with the focus on increasing the accessibility of cost efficient and flexible retirement plans for employees and individuals. However, political and budget realities suggest it may not be easy.

1Trump Tax Plan, pdf file from Google.

2Congressional Budget Office, “Further Limit Annual Contributions to Retirement Plans”, Budget Options, December 8, 2016.

3Assumes a 5% annual investment return for both scenarios

NOTE: Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Past performance is not a guarantee of future results.

About the Author

Frederic Slade

Frederic Slade is Assistant Vice President and Senior Director, Investments at Pentegra Retirement Services. He joined Pentegra in May 2007 as a Senior Analyst in the Investment Department and became Director-Investments in January 2013. He is responsible for managing over $1 billion in internal bond portfolios and providing asset/liability studies, analytics and product strategy for Pentegra’s Defined Benefit and Defined Contribution Plans. Mr. Slade is also a frequent contributor of economic and financial market blogs to Pentegra’s Talk to a Specialist website and the financial media. Prior to joining Pentegra, Mr. Slade was a Senior Quantitative Analyst at Citigroup Asset Management, providing asset allocation and quantitative stock screening for mutual fund products. Prior to Mr. Slade’s tenure at Citigroup, he was an Investment Manager at NYNEX Asset Management (now Verizon). At Verizon, Mr. Slade was responsible for asset allocation and planning for its $15 billion Defined Benefit pension fund. Mr. Slade holds a Ph.D. in Economics from the University of Pennsylvania and a CFA, and is a frequent presenter at industry seminars and conferences.