Fair you say? Before you read this, keep in mind that only compensation up to $285,000 can be used when making 401k contributions in 2020 so don’t think a person earning $600,000 can contribute a percentage of that.
I always find it amazing when an analysis concludes that a high income person who pays the highest taxes gets the greatest tax break when a portion of their income is taxed differently. Yup, and they are likely to save more too; another startling revelation.
These tax breaks are in truth tax deferral. That means taxes eventually are paid and here’s an amazing fact, when they are paid, higher income earners will still pay higher taxes.
Of course limiting the tax deferral percentage to less than the actual tax rate, means less taxes will be paid upon withdrawal.
Making the credit refundable is merely wealth transfer and does nothing to improve retirement income.
Besides, we should all be saving on an after-tax Roth basis in any case.
Under current law, workers contribute pretax dollars and thereby reduce their annual taxable income, but they pay full freight when funds are eventually withdrawn in retirement. The upfront tax break is larger for richer households, however, since deductions are more valuable the higher one’s tax bracket is.
For example, take a single filer in the top 37 percent bracket making $600,000; for each $1,000 she contributes to a 401(k) plan, her tax deduction is worth $370. A single filer earning $60,000, however, would be in the 22 percent bracket and only receive a $220 tax break for that same $1,000 contribution.
What’s more, upper-income earners tend to save more in 401(k) plans, which have an annual cap that rises with inflation; in 2020, the limit is $19,500, with an extra “catch-up” contribution of $6,500 allowed for those 50 or older. The more pretax dollars set aside, the larger the tax break is. Workers can also save $6,000 in 2020 in traditional individual retirement accounts, or $7,000 for those 50 or older.
Such contributions are fully deductible unless one or both spouses also have a workplace retirement plan, in which case the deduction phases out for higher earners.
Biden would instead “equalize” the incentive system by ending such deductions and replacing them with flat tax credits for each dollar saved. The campaign isn’t saying what that percentage would be, but the Urban-Brookings Tax Policy Center has estimated a 26 percent credit would be roughly revenue neutral over the first 20 years and beyond, which the Biden campaign is aiming for.
Under this plan, someone earning $600,000 would get the same tax break as someone making $60,000 — an identical $260 tax credit for their $1,000 retirement contribution. The credit would also be refundable, so someone earning too little for the credit to fully offset their income tax liability would still get the full tax credit.