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IRA Financial Blog

Biden Wants To Change The Solo 401(k) Plan – Episode 249

Adam Talks

IRA Financial’s Adam Bergman, Esq. discusses presidential hopeful Joe Biden’s plan to revamp the Solo 401(k) plan by incentivizing more people to save for retirement.

The simple fact of the matter is saving for retirement takes money. If you do not have the resources to do so, you can’t. Based on income, the amount of people saving is very glaring. Only 44% of Americans earning between $25,000 and $50,000 make retirement contributions. Unsurprisingly, 80% of those earning at least $225,000 are saving for retirement. Joe Biden hopes to help those who cannot afford to save with his 401(k) plan changes.

How Does the 401(k) Plan Work?

A 401(k) plan is a tax-advantaged way to save for retirement. Funds are contributed to the plan, and they grow tax-deferred until you start withdrawing after you retire. There are different types of contributions you can make, however, we will focus on the traditional plan, since they are the most popular option. Some plans may offer Roth or after-tax contributions options, however, not all do.

The traditional plan is funded with pretax funds, meaning you get an upfront tax deduction. The money in the 401(k) will grow tax deferred. Once you reach retirement, and start taking distributions, you will then be taxed on the amount you take each time. This allows the funds in the plan to grow unhindered for years or decades. Investments held personally (outside of a retirement plan) are taxed annually.

An Example: Let’s say you earn $25,000 per year at your job. Without a plan, you owe taxes on the entire amount the following year. However, any amount contributed, will lower your taxable income. Our example will contribute $2,000 to a 401(k) plan. This will lessen the taxable amount to $23,000. Either amount puts you in the 12% tax bracket, which means a $3,000 tax bill on the full amount, but only $2,760 if you contributed to the 401(k) as above.

Biden’s Plan

The above illustrates how the current retirement system works. You get a nice little tax deduction on your contributions. However, Biden wants to incentivize more lower-income Americans to save. His plan would eliminate the tax deduction in favor of a tax credit. As Mr. Bergman, a tax attorney, will tell you, a credit is better than a deduction. The former vice president would like a 26% tax credit. This is way more than the 12% deduction a lower income worker receives. Our previous example gets a $240 deduction for contributing $2,000 to his or her 401(k). Biden’s plan would give you a $520 credit. Essentially, you will have more in your retirement plan by contributing less.

Unlike other credits, this is not a “pure” credit. Instead, it’s a credit that goes into your 401(k) plan. Obviously, the credit is geared for lower income people, who receive the greater benefit. Higher earners won’t benefit, because they are in a higher tax bracket (much higher than the 26% credit they would receive).

Obviously, the plan is not geared for the rich, but instead to help out those who can’t afford to save a lot for retirement each year. However, those people who will see a drop in their tax deductions might look at the Roth option. Quickly, a Roth is funded with after-tax funds, meaning there is no deduction, however all qualified withdrawals are tax free. Many high earning individuals prefer the bigger tax break, but a Roth is a great option for them, so long as they don’t mind paying the extra taxes.

The Solo 401(k) Plan

A Solo 401(k) is a typical 401(k) plan that caters to the self-employed. One of the biggest benefits of the plan is how much you can contribute to the plan. A standard, workplace plan allows you to contribute up to $19,500, or $26,000 if you are at least age 50. For 2020, a Solo 401(k) contributor can save up to $57,000 (or $63,500)…way above that of the typical plan.

Obviously, if you are self-employed, this allows you to go above and beyond a typical workplace plan. Then benefits of the 26% credit would follow suit. A $30,000 contribution would lead to a $7,800 credit added to the plan. Once the contribution is maxed (including the credit) you cannot contribute anymore. Basically, you can’t max out your contribution anymore (if you have been). This is because you cannot exceed the annual limit. Those who have the ability to max out the plan already, may elect to go Roth and its tax-free distributions instead.

Will this Happen and Will it Work?

Not only does Biden have to win the election, but the Democrats must take over the Senate. Obviously, not everyone is on board with the plan, especially richer people. So, there’s no guarantee this change will happen. The retirement system works. It doesn’t need any type of major overhaul. However, incentivizing lower income workers to save is a great idea.

Is it a good plan? Who knows. There are probably better ways to help all people save for retirement. Retirement planning is never a hot topic, even during election years. Hopefully, whomever is president come January, will look at ways to help the American people save fore retirement.

We’d like to thank you for checking out this episode. Adam Bergman, and IRA Financial, does not offer a political opinion. We are bipartisan and will remain that way! We will be covering Donal Trump’s tax returns next episode. In fact, you can listen to it on our SoundCloud page right now!


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