Retirement Clients Concerned Over Federal Tax Policies

With the possibility of tax reform affecting deferral limits and other aspects of retirement savings, plan sponsors and their advisers are at critical positions to communicate a tax-conscious approach to retirement savings.  

Catherine Collinson, president of the Transamerica Center for Retirement Studies, tells PLANADVISER that many eligible participants may need to be reminded about the Saver’s Credit, a tax benefit designed to help low- and middle-income workers. For 2017, the maximum adjusted gross income needed to earn this benefit is $46,500 for tax payers filing as heads of household and $62,000 for married or joint filers.  

However, according to the latest Annual Transamerica Survey of Workers, only 33% of employees are aware of the Saver’s Credit, suggesting plan sponsors can benefit from informing participants about this benefit and how to file for it via form 8880. Collinson notes some participants could have free access to planning software via IRS.gov, which can help determine if they are eligible and how to file for the credit.

While awareness of specific tax benefits could be improved, there is a general consensus that most Americans want to preserve tax incentives of retirement plans. This preference even extends to people without retirement plans, according to a study by the Investment Company Institute.

Moreover, the Transamerica survey found that 34% of Americans believe extending the Saver’s Credit to all filers regardless of income should be a priority for incoming President Donald J. Trump and the new Congress.

Clearly, the idea of having a tax benefit to save for retirement is popular among Americans and helps to show that saving for retirement is the responsible thing to do. However, awareness of these incentives needs to be raised, experts agree. For example, retirement plan fiduciaries could nudge all of their employees in the right direction by utilizing a multimedia educational approach.

“For decades, being able to save on a tax-deferred basis has been a powerful motivator for people to save,” Collinson explains.

Next: Benefits of a Roth 401(k)

In 2017, workers can contribute up to $18,000 of their compensation into their 401(k) accounts on a pre-tax basis. Those aged 50 or older are eligible to make additional “catch up” contributions of up to an additional $6,000.

It’s important to note that 2016 marked the year the first Generation Xers reached age 50. However, only 48% of G Xers are aware of catch up contributions, according to Collinson. As for Baby Boomers, roughly two-thirds (67%) know about these benefits. Thus, plan sponsors and employers stand to gain from utilizing targeted communication to explain tax advantages offered to certain demographics.

Saving on an after-tax basis through a Roth 401(k) or Roth IRA can also be particularly appealing to investors who expect to find themselves in higher tax brackets at retirement and want to avoid a bigger tax hit down the road by paying them now. Not surprisingly, Collinson’s research finds that early career Millennials in particular are taking advantage of these vehicles.

Some investors can also benefit from combining traditional and Roth accounts to take a tax-diversified approach to retirement saving, making changes in the future strategy based on how tax laws change. For example, a higher tax environment anticipated down the road may make Roth 401(k) options more appealing today.

“Offering the two enables the participant to make choices based on affordability, long-term views of retirement, and the other thing which isn’t talked about as much—their tax risk,” explains Collinson.

Based on Transamerica’s research, just under half of plan sponsors offer a Roth 401(k) option, but Collinson notes that it came to inception in 2007, just before the economic downturn, when many plan sponsors were facing pressing challenges to maintaining their plans. “It’s conceivable that the Roth 401(k) got lost in the shuffle, so it is definitely worthy of plan advisers in working with plan providers to re-engage plan sponsors on the topic. From a recordkeeping perspective, it’s been as streamlined as much as it can be. So it’s a lot easier to administrate.” 

NEXT: What’s on the Table? 

According to The Center for Retirement Research at Boston College, the U.S. government subsidizes retirement savings through 401(k) plans alone with $82.7 billion in tax expenditures every year. Some industry analysts fear forthcoming tax policies will not be as generous.  

Dave Camp, retired representative and former Chairman of the House Ways and Means Committee, in 2014 rattled some industry groups looking to defend tax incentives when he made a series of proposals. These included freezing inflation adjustments to the annual contribution limits to 401(k)s and IRAs for ten years.

The Congressional Budget Office argues that tax reform could take a variety of paths, and explored some potential moves in a recent report. The 929-page paper points to possibilities such as treating Social Security benefits in ways similar to defined benefit (DB) distributions. According to the Transamerica survey, 77% of workers are concerned Social Security benefits won’t be around when they retire, and 58% cited funding the system as the top priority for Trump and Congress.

“As an industry and as a country, we should be concerned about any proposal that may try to gut an individual’s ability to save for retirement as a way to pay for other tax provisions,” warns Will Hansen, senior vice president of retirement policy, ERISA Industry Committee (ERIC).

Back in June, House Republicans unveiled a “blueprint” for simplifying the tax code. Although it was vague on retirement policy, the Tax Policy Center noted that the House Ways and Means Committee would examine existing tax incentives to create an “overall approach to retirement saving” and look toward “consolidation and reform of the multiple existing incentives.”

For some, this could mean a turn to a universal savings account. Hansen suggests these can fail to provide some of the protections offered by traditional retirement accounts, such as penalties to drawing into these funds before savers have reached retirement age.

“That might put a nail in the coffin for an individual’s ability to have funds for retirement,” says Hansen.