Retirement

GOP Tax Plan: are they insane or are they saviors?

By November 16, 2017 No Comments
GOP Tax Plan

GOP Tax Plan

As the days pass, the GOP continues to tinker with tax reform trying to create a new tax plan for the nation. The latest idea floated is another alteration to 401(k)plans. This is not the first time the GOP proposed changes to the way Americans save for retirement.

Senator Orrin Hatch proposed an amendment to the Senate version of the tax plan, according to Fox Business Network, Hatch’s amendments will change the rules for 401(K)s and IRAs, among other proposals.

He proposed increasing the “the catchup limit from $6,000 to $9,000” for those who are 50 years old or older, “but taxing those contributions when they are made and forcing them to become ROTH 401(k) contributions.”

Senator Hatch is being consistent with other GOP proposals, which were widely reported recently.

For instance, last month many were upset with talk that the GOP House version of the tax reform bill would slash the slash the maximum limit on pre-tax 401(k) contributions to $2,400 a year, down from the $18,000 IRS limit for Americans under 50 and $24,000 for Americans 50 or older in 2017.

The reason for the consistency? Congress is looking to generate more revenue today. The more money American savers defer in their pre-tax 401(k), the less government collects today.

Remember, 401(k)s allow the saver to defer paying taxes on the money deposited into these plans. That deferral can go on for decades.

By capping the amount of what can placed into a Traditional 401(k) and increasing the limits on a Roth 401(k), which is taxed today, the government could capture more tax dollars each year now. The savers will still be able to accumulate funds for retirement, and the portions deposited in the Roth 401(k), along with the growth or earnings on those funds, will be tax-free when withdrawn in retirement.

First reactions to this idea, as you could imagine, were not overly positive as many financial reporters scoffed at the idea of limiting how much a person could save for retirement.

CNBC went as far in its titled “Congressional Scrooges want to cut 401(k) contribution limits” article to state “If lawmakers have their way, taxpayers may have to work longer in their lives, work more hours or have to take more risk in the investment markets to live the retirement they envision now. This is what reducing the 401(k) plan contribution limit could mean. This is what Congress is calling “tax reform.”

Both sides of this argument are not really understanding the regulations that are the books, with respect to 401(k) and other pretax savings programs.

Congress is either ignorant or purposely misleading the public on what their own laws do to pretax retirement vehicles, with respect to raising revenue.

Major media outlets and the financial services industry rarely report on this, or their reporting doesn’t fully connect the dots with existing laws and regulations.

In fact, Congress may actually be doing a favor for all of those who want to save for their retirement through a traditional 401(k) by reducing the limits and forcing people into a Roth 401(k) through this new tax plan.

Read: Trad 401(k) or Roth 401(K)…it may all come down to planning for your health

What is on the books now:

1. Under current federal regulations when you are 65 years old or older and you are no longer covered by creditable health insurance through an employer or spouse’s employer, you must accept Medicare in order to receive your Social Security benefit.

2. Medicare is means tested. There are surcharges on enrollees who earn too much income through its Income Related Monthly Adjustment Amount (IRMAA). These surcharges apply to both Medicare Part B and Medicare Part D premiums.

The 2017 IRMAA brackets:

3. Income is defined as “your adjusted gross income PLUS any tax-exempt interest or everything on lines 37 and 8b or the IRS form 1040.

Some examples of income: wages, interest, capital gains, dividends, Social Security benefits, rental/pension income and distributions from tax-deferred investment.

4. Medicare Part B premiums and any surcharges imposed due to income are automatically deducted from any Social Security benefit received.

Note: that all surcharge collected get deposited into the General Fund of the U.S. Treasury to help pay down the debt or give Congress more money to spend each year.

Stating the obvious, this means your Social Security may be lighter than expected or forecasted by your financial advisor.

Read: How Medicare will consume your Social Security benefit

While retirement savings via a traditional 401(k) allow you to save taxes today, what you are doing is potentially increasing health costs and lowering your Social Security benefit.

Thanks to the required minimum distribution (RMD) when you reach 70.5 years old, you must start taking money out of your traditional 401(k) – whether you need the money or not.

These RMD’s count as income, and, when coupled with your Social Security benefit, your Medicare Part B and Part D premiums may increase if the RMD withdrawal causes you to report more income.

As mentioned above, your costs for Medicare as well as these surcharges are automatically deducted from your Social Security benefit.

Interestingly, withdrawals from Roth IRAs and Roth 401(k)s do not count as income for the purposes of subjecting you to surcharges on your Medicare.

Other options are qualified withdrawals from health saving accounts, 401(h) plans, home equity, and certain withdrawals from cash value life insurance.

By Congress limiting what you can invest into a Traditional 401(k) or by forcing you to invest in a Roth 401(k) for them obtain more tax revenue today, will ultimately help many later when they are financing and planning for health costs in retirement.

This tax plan by Congress also flies in the face of what they have already implemented in terms of regulations surrounding Social Security and Medicare and could quite possibly cost them trillions in revenue in less than 10 years as the Baby Boomers start to age.

Historically speaking, Medicare premiums have been inflating at over 7 percent. Going forward, there is a huge demographics problem with 76 million Baby Boomers heading to retirement. That’s an awful lot of people collecting Social Security and using Medicare.

In 2017, the national average for a retiree to be fully insured under Original Medicare is $4,650. For a retiree who triggers the first IRMAA bracket, the cost inflates to about $5,455. Again, this is the national average. The national average cost for a retiree in the highest IRMAA bracket, would be $9,100 for the same coverage.

Now inflate that by 7 percent over 20 years for a 65-year-old or 30 years for a 55-year-old, how much extra will they be paying throughout retirement?

With the Republicans in Congress doing something that some in the media are claiming will hurt your retirement in order that government can get paid today, what they are actually may be doing is something that controls your health costs and saves your Social Security benefit later at their own expense.

The question that now needs to be asked: Is the GOP insane to limit what people can save to fund their retirement in order to generate more revenue today or are they trying to save millions of retirees from having to pay higher health costs while also helping them keep more of their Social Security benefit at their own expense later on?

The higher probability, unfortunately, is that they don’t even really know what the regulations surrounding Medicare and Social Security really are.

Dan McGrath

Dan McGrath

Mr. McGrath is a Co-Founder of Healthcare Retirement Planner as well as Jester Financial Technologies. He is a best selling author, "What you don't know about retirement will hurt you" and is a nationally recognized speaker on how health costs impact retirement.