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  • Home>Research & Insights>Fund Times>Will 401(k) Plans Be 'Rothed'?

    Will 401(k) Plans Be 'Rothed'?

    Probably not, but it's a possibility.

    John Rekenthaler, 09/26/2017

    On the Docket
    This week, the Republican Party is expected to release its tax-reform proposal, crafted both by Congress and the White House administration. It is known that the GOP will reduce tax revenues by slashing the corporate rate, probably from 35% to 20% (the White House sought 15% but seems to have compromised) and by lowering the top marginal income-tax rate from 39.6% to 35%. Unclear, however, is which current tax benefits will be eliminated to pay for these tax cuts.

    This year's effort, as with so many reform bills before it, has opted against shooting elephants. Companies won't pay a "border tax" on their imports, as the GOP had recommended earlier this year, and home-mortgage payments will continue to be tax protected, as will charitable donations. Consequently, the GOP's tax-reform plan won't be revenue-neutral, absent a heroic increase in GDP growth.

    But that doesn't mean that the party isn't trying to close the revenue gap. One suggestion that the GOP has mulled, per Politico, is that 401(k) contributions lose their up-front tax shelter, so that the current year's plan investments would be made with aftertax money. This would boost federal revenues over the near term--although as we shall see, not over the long haul--and thereby improve the reform bill's 10-year projections.

    Under such a proposal, initial 401(k) contributions would be taxed (although employer matches, should the company offer such a benefit, would continue to be untaxed at the time of the contribution), the investment gains would be tax-free (as is the case today), and the retirement withdrawals would also be untaxed. In short, 401(k) plans would cease to behave like traditional IRAs and would instead act as do Roth IRAs (once again, aside from company matches). Current 401(k) rules permit companies to offer a Roth-style option to their employees, should they so desire. The suggested legislation would make that option mandatory. The 401(k) structure would be Rothed.

    Three questions:

    1) Should this happen?

    2) Will this happen?

    3) If it does happen, what will be the outcome?

    is vice president of research for Morningstar.