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Rothification May Make You Work Longer – Episode 217

rothification

IRA Financial’s Adam Bergman discuses the possible Rothification of retirement savings, which may lead many to work longer. There is talk of eliminating the upfront tax deduction of traditional retirement plans in favor of after-tax Roth 401(k) contributions.

In this podcast, Mr. Bergman speaks about a Wall Street Journal article that focuses on the rothification of retirement savings. Is eliminating the pre-tax 401(k) contribution a good idea? Will eliminating this tax break lead to people needing to work longer? In the following, Mr. Bergman will answer these questions and share his thoughts about the possible rothification of retirement plans.

Traditional vs. Roth 401(k)

As you probably know, 401(k) plans are a tax-advantaged way to save for retirement. Many companies offer them to help with their tax situation, as well as a tool to attract and retain employees. However, many people are unaware of the different types of 401(k) plans. Traditional plans are more widely offered, although more companies are starting to offer Roth 401(k) options. But, what’s the difference between the two?

Traditional 401(k)

The most popular workplace retirement plan is the traditional 401(k). These plans are funded with pre-tax money. This means all contributions made to the plan receive an upfront tax break. Taxes are deferred until you start withdrawing funds during retirement. For example, if you earn $60,000 for the year and contribute $10,000 to your 401(k), you will only pay taxes on $50,000 for that year. This is the ideal plan for those who are looking to save money on taxes each year.

Roth 401(k)

On the other hand, Roth 401(k) plans are funded with after-tax money. There is no tax break. You pay taxes on your entire earned income on the year, no matter how much you contribute to a Roth. The benefit comes when you reach retirement. You don’t pay any taxes on your qualified distributions from the plan. If you’re $10,000 contribution turns into $100,000, that entire $100k is tax-free!

What is “Rothification?”

As we all know, the government helps get funded via taxation of the American people. If you contribute to a traditional 401(k), you are not paying taxes for decades. The government is looking to pay down its $23 Trillion debt. Moreover, the DOL reports Social Security is underfunded by $43 Trillion! One thing that’s being considered is removing the tax break the traditional 401(k) affords. Basically, rothification would ensure that all workplace retirement savings are funded with after-tax money. No longer will Americans be allowed to defer paying taxes on these accounts.

As of this time, there is no talk about eliminating the Roth IRA. Americans will still be able to lower their tax bill by making Roth IRA contributions. However, IRA contributions are much lower, $6,000 vs. $19,500 for those under 50 years old in 2020. Will rothification solve the nation’s debt? Of course not, but they will explore all ways to do so.

How Will This Affect Retirement Savers?

First off, many Americans might start saving less. One of the best benefits in saving for retirement is the tax break. If there is no longer an immediate deduction, people may not want to contribute as much. Secondly, because there is no deduction, your take home pay would be less. With no deduction, your entire salary will be taxed come Tax Day. Currently, traditional contributions are the best way to lower your annual tax bill. If that’s taken away, experts think the working class would need to work an extra year (if not longer) to make up the difference.

On the other hand, if all 401(k) savings are via a Roth, many Americans might lean on that money once they hit the age of 59 1/2. This is when you are allowed to start reaping the tax-free benefits of the plan. Instead of tapping into Social Security when it becomes available, savers can delay that, which will increase their potential payout. This assumes, of course, that there’s still money left for Social Security payouts!

Will This Ever Happen?

Obviously, there is no definitive answer to that question. An estimated $2 trillion annually could be recouped by the government. While that’s not chump change, it’s just a drop in the bucket. Mr. Bergman references changing the rules mid-game. It will be hard pill to swallow if this ever comes to fruition. Although, thanks to the SECURE Act, we see the government will change the rules. Most aspects of the Act were positive, however, not all. The elimination of the Stretch IRA is one change that will have a negative impact.

Whatever happens, it’s still vitally important that Americans save as much as they can for retirement. For the most part, the system works and the 401(k) plan is one of the best ways to save. Rothification may have some negative impacts, however, it’s still an excellent way to save for retirement. This is assuming you can afford to fund it and also wait to distribute funds from the account.

As always, thanks for listening to the latest Adam Talks podcast! Be sure to check out our SoundCloud page as Adam Bergman discusses everything about retirement planning.

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