Author Topic: Biden 401k - Taxed Twice?  (Read 3697 times)

EricEng

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Biden 401k - Taxed Twice?
« on: January 25, 2021, 10:14:11 AM »
https://money.usnews.com/money/retirement/401ks/articles/president-bidens-proposed-changes-to-401-k-plans
I get how the 26% tax credit instead of tax deduction works, however that appears like you would get taxed twice and for high earners it would actually punish putting into 401k.  I can't see anything discussing how their proposal would look at withdrawals of money, apparently no change?  Treated like a Roth?

Old: Tax deferred
$19,500 off income now, $19,500(+growth) added to tax income years later when you withdraw

New: Tax credit
$19,500 taxed, 26% credit, then years later when you withdraw $19,500 you get taxed again unless it is treated like Roth?
If you are in the 30+% tax bracket it appears you would get taxed when you earned and deposited and taxed again when you withdraw where as if you had never put in the first place you would actually be paying less even with the credit.

Only way I see this working out is if they treat it as a Roth which seems too generous to everyone or if you are in 12% or lower bracket both at time of earning and withdrawing which barely comes out ahead.

RWD

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Re: Biden 401k - Taxed Twice?
« Reply #1 on: January 25, 2021, 10:46:01 AM »
Hmm, this is interesting. Seems like it would be better than the current system for anyone in a tax bracket under 26%. For someone in one of the tax brackets above 26% whether it's still worth contributing would probably depend on how many years of tax-free compounding you will get and your expected retirement tax bracket.

ixtap

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Re: Biden 401k - Taxed Twice?
« Reply #2 on: January 25, 2021, 10:54:05 AM »
We normally use effective tax rates, not tax brackets, during accumulation in making t vs Roth calculations.

Giving a tax credit and Roth status would be quite the bonus to everyone, except that it wouldn't make any sense from a tax revenue perspective.

Getting fewer high income people to shelter their income is a feature, not a bug.

DaMa

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Re: Biden 401k - Taxed Twice?
« Reply #3 on: January 25, 2021, 11:04:11 AM »
Say you contribute $10,000 now and you are in the 25% bracket.  You save $2500 on taxes, but you'll pay taxes when you withdraw.

Under Biden plan, you contribute after tax, so you'd have to earn $13,333, paying $3,333 in taxes, to contribute $10,000.  You'd then get a 26% tax credit for $2600.  So it looks like you made an extra $100, but really you paid an extra $733.



EricEng

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Re: Biden 401k - Taxed Twice?
« Reply #4 on: January 25, 2021, 11:09:54 AM »
Say you contribute $10,000 now and you are in the 25% bracket.  You save $2500 on taxes, but you'll pay taxes when you withdraw.

Under Biden plan, you contribute after tax, so you'd have to earn $13,333, paying $3,333 in taxes, to contribute $10,000.  You'd then get a 26% tax credit for $2600.  So it looks like you made an extra $100, but really you paid an extra $733.
So you assume since you are putting in After Tax, you'd withdraw all as after Tax, ie Roth?  That is the original question of this thread.  How are withdraws treated.

DaMa

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Re: Biden 401k - Taxed Twice?
« Reply #5 on: January 25, 2021, 11:20:05 AM »
If it is a Roth 401k, then this is a $2600 tax credit we don't have now.  WooHOO!  That's obvious.  The article says it's meant to bring fairness between high and low earner, which an extra tax credit would not do. Therefore it is not a Roth 401k. 


RWD

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Re: Biden 401k - Taxed Twice?
« Reply #6 on: January 25, 2021, 11:27:54 AM »
Say you contribute $10,000 now and you are in the 25% bracket.  You save $2500 on taxes, but you'll pay taxes when you withdraw.

Under Biden plan, you contribute after tax, so you'd have to earn $13,333, paying $3,333 in taxes, to contribute $10,000.  You'd then get a 26% tax credit for $2600.  So it looks like you made an extra $100, but really you paid an extra $733.

No, there is a $100 benefit in your scenario. Because you need to assume your income doesn't change both before and after. I'll use the 25% tax bracket assumption below even though that doesn't exist currently (22% and 24% are the closest brackets).

Current system:
$13,333 [marginal] income
-$10k 401k contribution
= $3,333 taxable * 0.25 = $833.25 tax

Biden tax credit change:
$13,333 income * 0.25 = $3,333.25 tax
$10k contribution * 0.26 = $2,600 credit
Final tax burden = 3333.25-2600 = $733.25

seattlecyclone

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Re: Biden 401k - Taxed Twice?
« Reply #7 on: January 25, 2021, 11:28:43 AM »
I expect the taxation of withdrawals would not change. This would mean that you'd compare your expected marginal rate in retirement to 26% when deciding between traditional or Roth, instead of comparing to your current marginal rate.

We normally use effective tax rates, not tax brackets, during accumulation in making t vs Roth calculations.

Some people do this, and they are wrong. This has been discussed extensively elsewhere.

seattlecyclone

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Re: Biden 401k - Taxed Twice?
« Reply #8 on: January 25, 2021, 11:33:48 AM »
Say you contribute $10,000 now and you are in the 25% bracket.  You save $2500 on taxes, but you'll pay taxes when you withdraw.

Under Biden plan, you contribute after tax, so you'd have to earn $13,333, paying $3,333 in taxes, to contribute $10,000.  You'd then get a 26% tax credit for $2600.  So it looks like you made an extra $100, but really you paid an extra $733.

No, there is a $100 benefit in your scenario. Because you need to assume your income doesn't change both before and after. I'll use the 25% tax bracket assumption below even though that doesn't exist currently (22% and 24% are the closest brackets).

Current system:
$13,333 [marginal] income
-$10k 401k contribution
= $3,333 taxable * 0.25 = $833.25 tax

Biden tax credit change:
$13,333 income * 0.25 = $3,333.25 tax
$10k contribution * 0.26 = $2,600 credit
Final tax burden = 3333.25-2600 = $733.25

Yep, this is correct. This change might have other follow-on consequences though. Under current law your traditional 401(k) contributions are excluded from AGI. Under the new law they wouldn't be excluded, which would impact things like ACA subsidies and other tax credits. Many lower-income folks would be made better off by this change, but some (especially those who save a lot) might not.

DaMa

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Re: Biden 401k - Taxed Twice?
« Reply #9 on: January 25, 2021, 11:45:11 AM »
Thanks @RWD.  I had a feeling I was missing something.

EricEng

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Re: Biden 401k - Taxed Twice?
« Reply #10 on: January 25, 2021, 12:11:57 PM »
I expect the taxation of withdrawals would not change. This would mean that you'd compare your expected marginal rate in retirement to 26% when deciding between traditional or Roth, instead of comparing to your current marginal rate.
So you would be taxed twice?  Taxed when you earned it, and taxed when you withdraw it?  Just counting on the 26% to be larger than one of those times?

DaMa

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Re: Biden 401k - Taxed Twice?
« Reply #11 on: January 25, 2021, 12:33:52 PM »
The $2600 tax credit is essentially a rebate of the taxes you paid on your contribution, so you are really only taxed at withdrawal.  If you are paying taxes over 26% on contribution, than that could be paid twice.

Would it still be worth it if you were paying a lower tax rate on withdrawal?  I've never run numbers over 25% tax rate -- never had that high of an income. 

Alternatepriorities

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Re: Biden 401k - Taxed Twice?
« Reply #12 on: January 25, 2021, 12:40:11 PM »
This plan looks like it would create a crazy bonus for Mustachians in the 12% bracket. Which, for MFJ is effectively $105k with the two standard deductions!

Max out 2 401ks for 39k and get a tax credit of $10140 - 4680 = $5,460 on top of deferring tax. If the code doesn't change (highly unlikely) the first $25100 is a 0% and then the marginal rates kick in from there. A Mustachian couple pulling 60k a year is looking at approximately a 6% effective tax rate meaning that 26% credit becomes a 20% bonus... This all seems a little to sweet to be sustainable but maybe there are so few of us who would do it that it won't matter?

It seems like someone who wants to barista fire could get even more with planning. Assuming a Roth that has sufficient funds to support this ladder for 5 years. A couple earns 39k and contributes all of it to 401k so they get the $10140 credit above. Rolls 29k into their Roth and pays $390 in taxes after the 2 standard deductions. They can then pull 29k from the Roth to live on. Presto! a $38,750 a year life with an effective tax rate less than 1%. Of course only people on this forum are ever likely to do something so complicated... :)
« Last Edit: January 25, 2021, 12:42:10 PM by Alternatepriorities »

Retireatee1

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Re: Biden 401k - Taxed Twice?
« Reply #13 on: January 25, 2021, 12:54:05 PM »
It is double taxation (now and later) if you are in the 32% tax bracket or above, and in the 24% brackets and below it is a tax credit now and single taxation later.  In the 24% bracket it is close to being a wash with the old law, though.

So that first round of taxation will result in increased tax revenues in the near term for the Federal government.

reeshau

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Re: Biden 401k - Taxed Twice?
« Reply #14 on: January 25, 2021, 12:56:24 PM »
Getting fewer high income people to shelter their income is a feature, not a bug.

+1

It's not that hard to figure out, unless you are trying to contort it into the parameters of the current system.  Anyone paying under 26% in taxes has even more reason to save, and those paying higher taxes have less reason.  Don't like it?  Then don't do it.  EOM

Retireatee1

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Re: Biden 401k - Taxed Twice?
« Reply #15 on: January 25, 2021, 01:05:38 PM »
Getting fewer high income people to shelter their income is a feature, not a bug.

+1

It's not that hard to figure out, unless you are trying to contort it into the parameters of the current system.  Anyone paying under 26% in taxes has even more reason to save, and those paying higher taxes have less reason.  Don't like it?  Then don't do it.  EOM

Non-retirement accounts are double-taxed as well.  In that case, you have full income taxes at first, and then lighter taxes (capital gains rate) on the gains only (cost basis) when taxable events occur.  With the old law, you have single taxation at withdrawal in the form of full income taxes with no cost basis.  With this proposal, you have these lighter income taxes at first, and then full income taxes second with no cost basis.  The rich will have to compare this with a non-retirement account.  It may or may not still be worthwhile.  I will need to run some simulations.

Alternatepriorities

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Re: Biden 401k - Taxed Twice?
« Reply #16 on: January 25, 2021, 01:06:19 PM »
Thinking about it more the Roth ladder while working plan is worth doing for anyone in the 12% bracket and maybe even the 22% bracket. I meant a 4% bonus on 39k is still a free $1,560 right? The lottery is a tax on people who are bad a math and this is a tax credit for people who are good at math and don't make too much money... Assuming it passes, it remains to be seen if will actually encourage people of the H&R Block persuasion to save more for retirement or to even to do some paperwork and planning for free money.

On that thought... Can I contribute my wife's earnings to my i401k as "employee contribution" or does the business actually need to have earnings?
« Last Edit: January 25, 2021, 01:14:23 PM by Alternatepriorities »

EricEng

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Re: Biden 401k - Taxed Twice?
« Reply #17 on: January 25, 2021, 01:07:38 PM »
This plan looks like it would create a crazy bonus for Mustachians in the 12% bracket. Which, for MFJ is effectively $105k with the two standard deductions!

Max out 2 401ks for 39k and get a tax credit of $10140 - 4680 = $5,460 on top of deferring tax. If the code doesn't change (highly unlikely) the first $25100 is a 0% and then the marginal rates kick in from there. A Mustachian couple pulling 60k a year is looking at approximately a 6% effective tax rate meaning that 26% credit becomes a 20% bonus... This all seems a little to sweet to be sustainable but maybe there are so few of us who would do it that it won't matter?
There would be no deferring tax.  You lose the tax deduction (the deferral) and only get the one time tax credit.
Quote
It's not that hard to figure out, unless you are trying to contort it into the parameters of the current system.  Anyone paying under 26% in taxes has even more reason to save, and those paying higher taxes have less reason.  Don't like it?  Then don't do it.  EOM
Except, that just doesn't make sense if you are double taxing.

Scenario 1: 24% Marginal Tax Rate at earnings/contribution and withdraw
Put $19,500 into 401k, get $5,070 credit while taxed $4,680 at earnings time.
Years later, withdraw $19,500 and pay $4,680 a second time (not to mention decades of growth that will be treated as income instead of cap gains)
Total Tax Paid: $9,360-$5,070=$4290+standard tax on any gains

Scenario 2: 24% Marginal Tax Rate at earnings/contribution and withdraw
Put $19,500 in after tax brokerage, pay tax of $4,680 at earnings time.
Years later, withdraw $19,500 and only pay cap gains tax on gains above $19,500.
Total Tax Paid: $4,680+cap gains tax on any gains

Seems like scenario 2 is far better because all your gains will be taxed at 0 or 15% cap gains rate where as scenario 1 results in it all being standard income.  If you are above 24% tax rate you'll actually be in the hole using a 401k.

Alternatepriorities

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Re: Biden 401k - Taxed Twice?
« Reply #18 on: January 25, 2021, 01:17:26 PM »
This plan looks like it would create a crazy bonus for Mustachians in the 12% bracket. Which, for MFJ is effectively $105k with the two standard deductions!

Max out 2 401ks for 39k and get a tax credit of $10140 - 4680 = $5,460 on top of deferring tax. If the code doesn't change (highly unlikely) the first $25100 is a 0% and then the marginal rates kick in from there. A Mustachian couple pulling 60k a year is looking at approximately a 6% effective tax rate meaning that 26% credit becomes a 20% bonus... This all seems a little to sweet to be sustainable but maybe there are so few of us who would do it that it won't matter?
There would be no deferring tax.  You lose the tax deduction (the deferral) and only get the one time tax credit.
Perhaps that was badly worded. Under the current system the 12% tax deferral is $4680. I was attempting to point out that the credit provides $5460 above and beyond that.

DaMa

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Re: Biden 401k - Taxed Twice?
« Reply #19 on: January 25, 2021, 01:27:04 PM »
My son asked me a few weeks ago what I knew about the Biden 401k plan.  He was concerned.  I said, I don't know anything, but I'm sure if it gets any traction I'll hear more.

I love these boards.  Thank you all!

Alternatepriorities

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Re: Biden 401k - Taxed Twice?
« Reply #20 on: January 25, 2021, 01:37:06 PM »
My son asked me a few weeks ago what I knew about the Biden 401k plan.  He was concerned.  I said, I don't know anything, but I'm sure if it gets any traction I'll hear more.

I love these boards.  Thank you all!

Yeah, the main reason I looked into it at all is that people keep asking about it. Most of them seem to be worried it will cost them money and most of them are wrong... The changes to AGi would have negatively impacted one couple i know if they were in place last year, but it won't be an issue in the future. It was a whole mess with ACA subsidies and two people with significantly different earnings getting married late in the year...

My objection that it's just another way to give tax breaks to people who are good at math pretty much applies to our entire tax code... Which makes the forum invaluable.

reeshau

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Re: Biden 401k - Taxed Twice?
« Reply #21 on: January 25, 2021, 01:55:00 PM »
Scenario 1: 24% Marginal Tax Rate at earnings/contribution and withdraw
Put $19,500 into 401k, get $5,070 credit while taxed $4,680 at earnings time.
Years later, withdraw $19,500 and pay $4,680 a second time (not to mention decades of growth that will be treated as income instead of cap gains)
Total Tax Paid: $9,360-$5,070=$4290+standard tax on any gains

Scenario 2: 24% Marginal Tax Rate at earnings/contribution and withdraw
Put $19,500 in after tax brokerage, pay tax of $4,680 at earnings time.
Years later, withdraw $19,500 and only pay cap gains tax on gains above $19,500.
Total Tax Paid: $4,680+cap gains tax on any gains

Seems like scenario 2 is far better because all your gains will be taxed at 0 or 15% cap gains rate where as scenario 1 results in it all being standard income.  If you are above 24% tax rate you'll actually be in the hole using a 401k.

True for us, although the tax plan will tax long-term cap gains at ordinary income, above $1M.  So, there is a loophole, but for the targets of these changes ("millionaires," misused as income) there will be a modest benefit to the traditional thinking.

I wonder how long and how large the loophole will remain, though, once pointed out.  There's probably not much sympathy if we cry about our 0% cap gains bracket.

dcheesi

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Re: Biden 401k - Taxed Twice?
« Reply #22 on: January 25, 2021, 02:04:39 PM »
The other piece of this is state taxes. If the 401k contributions now show up in federal AGI, then presumably many states w/ income tax will be taxing that money. That could negate a lot of the benefit from this change for people in the 24% federal bracket.

EricEng

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Re: Biden 401k - Taxed Twice?
« Reply #23 on: January 25, 2021, 02:08:12 PM »
The other piece of this is state taxes. If the 401k contributions now show up in federal AGI, then presumably many states w/ income tax will be taxing that money. That could negate a lot of the benefit from this change for people in the 24% federal bracket.
I didn't even think of that.  If state tax is 5% at contribution and again at withdraw that's 10% out right there.  Surely they can't be intending to double tax these things.

DaMa

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Re: Biden 401k - Taxed Twice?
« Reply #24 on: January 25, 2021, 02:14:08 PM »
States could enact their own credits or put in a line to deduct 401k contributions.  That's the kind of tax cut (no real cost) some state representative would love to initiate.

seattlecyclone

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Re: Biden 401k - Taxed Twice?
« Reply #25 on: January 25, 2021, 02:19:05 PM »
There would be no deferring tax.  You lose the tax deduction (the deferral) and only get the one time tax credit.

Suppose there was a 26% tax bracket, and ignore the existence of other tax credits that phase in/out depending on your AGI. If you were in that 26% bracket, is there any difference at all between a 26% tax credit on a $10,000 contribution versus a $10,000 exclusion from your income? Not really. If you're in a bracket lower than 26%, a 26% tax credit is better than a deduction, and if you're in a higher bracket the tax credit is worse than a deduction. You could say "you get a tax credit and then you're taxed twice" if you want, and you wouldn't be wrong, but when the credit is more than the first taxation you're still better off than a straight tax deferral.

Quote
Scenario 1: 24% Marginal Tax Rate at earnings/contribution and withdraw
Put $19,500 into 401k, get $5,070 credit while taxed $4,680 at earnings time.
Years later, withdraw $19,500 and pay $4,680 a second time (not to mention decades of growth that will be treated as income instead of cap gains)
Total Tax Paid: $9,360-$5,070=$4290+standard tax on any gains

Scenario 2: 24% Marginal Tax Rate at earnings/contribution and withdraw
Put $19,500 in after tax brokerage, pay tax of $4,680 at earnings time.
Years later, withdraw $19,500 and only pay cap gains tax on gains above $19,500.
Total Tax Paid: $4,680+cap gains tax on any gains

Remember to use the same starting amounts and units in both scenarios.

In Scenario 1, to make your $19,500 traditional contribution you contribute $19,500 of pre-tax money and then get a tax refund of $390 that you could invest post-tax.

In Scenario 2, you can take that same $19,500 of pre-tax money, convert it to $14,820 of post-tax money, and invest that.

Suppose that whichever choice you make, your investment triples in value by the time you want to withdraw it, with no dividends in between to make the taxable math more complicated.

In Scenario 1 that means you have $58,500 in your 401(k) and $1,170 in taxable ($390 basis). Remain in the 24% bracket in retirement (15% for capital gains) and you pay $14,040 of tax from your 401(k) and $117 on your capital gains, leaving you with $45,513 in your checking account.

In Scenario 2 you end up with $44,460 in your taxable account prior to withdrawal, of which $14,820 is basis. You'll pay $4,446 in capital gains tax and end up with $40,014 in your checking account after paying your tax.

Compare these to a Scenario 1a (tax-deferred 401(k) contributions under current law). It's the same as Scenario 1 except you didn't have the extra $390 to invest post-tax, so you're still better off than Scenario 2, but a bit worse off than Scenario 1.

seattlecyclone

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Re: Biden 401k - Taxed Twice?
« Reply #26 on: January 25, 2021, 02:43:59 PM »
Thinking about it more the Roth ladder while working plan is worth doing for anyone in the 12% bracket and maybe even the 22% bracket. I meant a 4% bonus on 39k is still a free $1,560 right?

This leads to another interesting idea. If you decide that a Roth contribution would be a good idea because you expect your tax bracket to be higher in retirement, you might be better off making a traditional contribution and immediately converting it to Roth.

Suppose you're in the 12% bracket and have $19,500 of post-tax money to save. You could of course put that $19,500 in your Roth directly. Alternatively you could put the $19,500 into a pre-tax 401(k), get your $5,070 tax credit, convert to Roth (paying 12% * $1,900 = $2,340) and end up with $19,500 in your Roth and $2,730 in your checking account.

For tax brackets lower than 26%, the main reason you might want to do a direct Roth contribution instead of this immediate conversion thing would be if the conversion would increase your AGI to the next tax bracket, phase-outs of other tax credits from the AGI increase would bump your marginal rate on this maneuver up above 26%, or you really need the immediate penalty-free access that a direct contribution provides. Even for this last reason, if you're in the 12% bracket it's better to pay negative 14% on the contribution and 10% on the withdrawal than zero on both steps.

mistymoney

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Re: Biden 401k - Taxed Twice?
« Reply #27 on: January 25, 2021, 02:52:56 PM »
Is this supposed to be handled during payroll - or at tax time?

If at tax time, some people may not be able to contribute as much, may have the exact opposite effect for those that need it most.

Seems difficult to implement via payroll, but that is where it would be the most helpful.

Retireatee1

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Re: Biden 401k - Taxed Twice?
« Reply #28 on: January 25, 2021, 02:55:02 PM »
Thinking about it more the Roth ladder while working plan is worth doing for anyone in the 12% bracket and maybe even the 22% bracket. I meant a 4% bonus on 39k is still a free $1,560 right?

This leads to another interesting idea. If you decide that a Roth contribution would be a good idea because you expect your tax bracket to be higher in retirement, you might be better off making a traditional contribution and immediately converting it to Roth.

Suppose you're in the 12% bracket and have $19,500 of post-tax money to save. You could of course put that $19,500 in your Roth directly. Alternatively you could put the $19,500 into a pre-tax 401(k), get your $5,070 tax credit, convert to Roth (paying 12% * $1,900 = $2,340) and end up with $19,500 in your Roth and $2,730 in your checking account.

For tax brackets lower than 26%, the main reason you might want to do a direct Roth contribution instead of this immediate conversion thing would be if the conversion would increase your AGI to the next tax bracket, phase-outs of other tax credits from the AGI increase would bump your marginal rate on this maneuver up above 26%, or you really need the immediate penalty-free access that a direct contribution provides. Even for this last reason, if you're in the 12% bracket it's better to pay negative 14% on the contribution and 10% on the withdrawal than zero on both steps.

It definitely makes sense to do the Roth conversion instead of the direct Roth contribution in these cases.  It's going to create a lot of confusion, though.

seattlecyclone

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Re: Biden 401k - Taxed Twice?
« Reply #29 on: January 25, 2021, 03:01:41 PM »
Is this supposed to be handled during payroll - or at tax time?

If at tax time, some people may not be able to contribute as much, may have the exact opposite effect for those that need it most.

Seems difficult to implement via payroll, but that is where it would be the most helpful.

I'd expect them to update the withholding formulas to cover this tax credit, just as they've done for other tax credits.

RWD

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Re: Biden 401k - Taxed Twice?
« Reply #30 on: January 25, 2021, 03:03:17 PM »
Is this supposed to be handled during payroll - or at tax time?

If at tax time, some people may not be able to contribute as much, may have the exact opposite effect for those that need it most.

Seems difficult to implement via payroll, but that is where it would be the most helpful.
From a payroll perspective you can just decrease the withholding to keep taxes the same or lower. That's all payroll taxes are anyway, just estimates of what you'll owe when you file your return. With very low income you may hit a floor where taxes hit zero but that won't result in a decrease in the amount you can contribute to a 401k relative to the current system.

(Heh, @seattlecyclone  beat me to it.)

Alternatepriorities

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Re: Biden 401k - Taxed Twice?
« Reply #31 on: January 25, 2021, 04:21:24 PM »
Thinking about it more the Roth ladder while working plan is worth doing for anyone in the 12% bracket and maybe even the 22% bracket. I meant a 4% bonus on 39k is still a free $1,560 right?

This leads to another interesting idea. If you decide that a Roth contribution would be a good idea because you expect your tax bracket to be higher in retirement, you might be better off making a traditional contribution and immediately converting it to Roth.

Suppose you're in the 12% bracket and have $19,500 of post-tax money to save. You could of course put that $19,500 in your Roth directly. Alternatively you could put the $19,500 into a pre-tax 401(k), get your $5,070 tax credit, convert to Roth (paying 12% * $1,900 = $2,340) and end up with $19,500 in your Roth and $2,730 in your checking account.

For tax brackets lower than 26%, the main reason you might want to do a direct Roth contribution instead of this immediate conversion thing would be if the conversion would increase your AGI to the next tax bracket, phase-outs of other tax credits from the AGI increase would bump your marginal rate on this maneuver up above 26%, or you really need the immediate penalty-free access that a direct contribution provides. Even for this last reason, if you're in the 12% bracket it's better to pay negative 14% on the contribution and 10% on the withdrawal than zero on both steps.

Thanks seattlecyclone, you've eased my fears that I might have missed something in the plan. It would really change the way we allocate money to buckets, but in the end it would just mean more money to put in those buckets.

Alternatepriorities

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Re: Biden 401k - Taxed Twice?
« Reply #32 on: January 25, 2021, 04:23:41 PM »
Thinking about it more the Roth ladder while working plan is worth doing for anyone in the 12% bracket and maybe even the 22% bracket. I meant a 4% bonus on 39k is still a free $1,560 right?

This leads to another interesting idea. If you decide that a Roth contribution would be a good idea because you expect your tax bracket to be higher in retirement, you might be better off making a traditional contribution and immediately converting it to Roth.

Suppose you're in the 12% bracket and have $19,500 of post-tax money to save. You could of course put that $19,500 in your Roth directly. Alternatively you could put the $19,500 into a pre-tax 401(k), get your $5,070 tax credit, convert to Roth (paying 12% * $1,900 = $2,340) and end up with $19,500 in your Roth and $2,730 in your checking account.

For tax brackets lower than 26%, the main reason you might want to do a direct Roth contribution instead of this immediate conversion thing would be if the conversion would increase your AGI to the next tax bracket, phase-outs of other tax credits from the AGI increase would bump your marginal rate on this maneuver up above 26%, or you really need the immediate penalty-free access that a direct contribution provides. Even for this last reason, if you're in the 12% bracket it's better to pay negative 14% on the contribution and 10% on the withdrawal than zero on both steps.

It definitely makes sense to do the Roth conversion instead of the direct Roth contribution in these cases.  It's going to create a lot of confusion, though.

This is what i mean by a tax break for people with middle class incomes who are good with numbers. Or have a good accountant...

seattlecyclone

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Re: Biden 401k - Taxed Twice?
« Reply #33 on: January 25, 2021, 04:32:50 PM »
Thanks seattlecyclone, you've eased my fears that I might have missed something in the plan. It would really change the way we allocate money to buckets, but in the end it would just mean more money to put in those buckets.

They could certainly write the bill to close this loophole somehow. We'll have to see what Congress passes, if they even take up this idea at all.

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Re: Biden 401k - Taxed Twice?
« Reply #34 on: January 25, 2021, 04:39:45 PM »
Thanks seattlecyclone, you've eased my fears that I might have missed something in the plan. It would really change the way we allocate money to buckets, but in the end it would just mean more money to put in those buckets.

They could certainly write the bill to close this loophole somehow. We'll have to see what Congress passes, if they even take up this idea at all.

True. I probably would have maintained my usual "ignore it until is passes" plan if I so many friends/relatives hadn't contacted me with concerns. One aunt in particular was really worried.

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Re: Biden 401k - Taxed Twice?
« Reply #35 on: January 25, 2021, 07:50:18 PM »
Thanks seattlecyclone, you've eased my fears that I might have missed something in the plan. It would really change the way we allocate money to buckets, but in the end it would just mean more money to put in those buckets.

They could certainly write the bill to close this loophole somehow. We'll have to see what Congress passes, if they even take up this idea at all.

True. I probably would have maintained my usual "ignore it until is passes" plan if I so many friends/relatives hadn't contacted me with concerns. One aunt in particular was really worried.

This is where I am at. Not only has it not passed, it hasn't been proposed. Not only has it not been proposed, as far as I can tell the bill hasn't even been written yet. It seems premature to start getting into the details of a bill that doesn't exist.

jpdx

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Re: Biden 401k - Taxed Twice?
« Reply #36 on: January 25, 2021, 08:42:39 PM »
From a public policy perspective, I think the Biden proposal makes more sense than current law. If the goal of these tax advantaged accounts is to encourage people to save for retirement, shouldn't the amount of encouragement be the same for everyone?

With current law, say two different people contribute the same $10,000 to their retirement accounts, one might receive a $1200 subsidy and the other might receive a $3500 subsidy. Under this proposal, each would receive a $2600 subsidy.

EricEng

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Re: Biden 401k - Taxed Twice?
« Reply #37 on: January 26, 2021, 11:29:39 AM »
Thanks seattlecyclone, you've eased my fears that I might have missed something in the plan. It would really change the way we allocate money to buckets, but in the end it would just mean more money to put in those buckets.

They could certainly write the bill to close this loophole somehow. We'll have to see what Congress passes, if they even take up this idea at all.

True. I probably would have maintained my usual "ignore it until is passes" plan if I so many friends/relatives hadn't contacted me with concerns. One aunt in particular was really worried.

This is where I am at. Not only has it not passed, it hasn't been proposed. Not only has it not been proposed, as far as I can tell the bill hasn't even been written yet. It seems premature to start getting into the details of a bill that doesn't exist.
Sure, nothing has passed.  However, we are here because we like to discuss.  This is novel and would be a big change.  So we enjoy discussing it.  In this case, I was confused at the prospect of double taxation of the same dollar.

Thanks Seattle, I did make a mistake in my math.  However, I still think this will be straight negative for anyone in a higher tax bracket than 24% on either end.  For those hanging out in the 12% though it should work well.  For those at 24% I'm not sure the loss of liquidity is worth the small benefit unless they can confidently drop their tax bracket in retirement.  This really will complicate the math for folks and won't be a obvious good solution for everyone.

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Re: Biden 401k - Taxed Twice?
« Reply #38 on: January 26, 2021, 11:50:12 AM »
Sure, nothing has passed.  However, we are here because we like to discuss.  This is novel and would be a big change.  So we enjoy discussing it.  In this case, I was confused at the prospect of double taxation of the same dollar.

Thanks Seattle, I did make a mistake in my math.  However, I still think this will be straight negative for anyone in a higher tax bracket than 24% on either end.  For those hanging out in the 12% though it should work well.  For those at 24% I'm not sure the loss of liquidity is worth the small benefit unless they can confidently drop their tax bracket in retirement.  This really will complicate the math for folks and won't be a obvious good solution for everyone.

Don't forget that everyone gets the standard deduction in retirement too. (Assuming the rules don't change) That means regardless of current rules or the proposed ones you can delay those taxes and pay nothing on $12,550 per person in retirement. If we pretend for a moment that everything will be the same once you start Roth laddering into FIRE or retire a normal age. 4% rule suggests we should put away at least $312,500 (or $625,000 for a couple) in tax deferred accounts from any income that is taxed at all if possible.

terran

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Re: Biden 401k - Taxed Twice?
« Reply #39 on: January 26, 2021, 11:55:34 AM »
I'd actually say this will simplify the math. Now everyone should compare their current marginal tax bracket to their expected marginal tax bracket in retirement. If this change became law then everyone should compare their expected marginal tax bracket in retirement to 26%. Basically, it would mean any mustachian should contribute to traditional unless they firmly believe tax brackets for low income people will rise drastically in the future. The possible exception would be a highish spending mustachian retiring in a higher income tax state than they're in now who's planning to get ACA premium subsidies.

EvenSteven

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Re: Biden 401k - Taxed Twice?
« Reply #40 on: January 26, 2021, 12:48:29 PM »
Thanks seattlecyclone, you've eased my fears that I might have missed something in the plan. It would really change the way we allocate money to buckets, but in the end it would just mean more money to put in those buckets.

They could certainly write the bill to close this loophole somehow. We'll have to see what Congress passes, if they even take up this idea at all.

True. I probably would have maintained my usual "ignore it until is passes" plan if I so many friends/relatives hadn't contacted me with concerns. One aunt in particular was really worried.

This is where I am at. Not only has it not passed, it hasn't been proposed. Not only has it not been proposed, as far as I can tell the bill hasn't even been written yet. It seems premature to start getting into the details of a bill that doesn't exist.
Sure, nothing has passed.  However, we are here because we like to discuss.  This is novel and would be a big change.  So we enjoy discussing it.  In this case, I was confused at the prospect of double taxation of the same dollar.

Thanks Seattle, I did make a mistake in my math.  However, I still think this will be straight negative for anyone in a higher tax bracket than 24% on either end.  For those hanging out in the 12% though it should work well.  For those at 24% I'm not sure the loss of liquidity is worth the small benefit unless they can confidently drop their tax bracket in retirement.  This really will complicate the math for folks and won't be a obvious good solution for everyone.

Oh sure, I'm not the forum police and wasn't intending to make decrees about what people can and cannot discuss. My point was that from what I can tell, the details of "The Biden administrations proposed 401(k) changes" are derived from a few broad level and vague statements from various campaign staffers stitched together, or from some policy paper put out by the urban institute in 2016. My complaint is the quality of the data for determining what the "Biden 401(k) proposal" actually is.

This might just be my impression, and maybe the administration has recently put out an actual policy proposal, in which case a link would be appreciated and you can ignore my rantings.

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Re: Biden 401k - Taxed Twice?
« Reply #41 on: January 26, 2021, 02:12:18 PM »
Oh sure, I'm not the forum police and wasn't intending to make decrees about what people can and cannot discuss. My point was that from what I can tell, the details of "The Biden administrations proposed 401(k) changes" are derived from a few broad level and vague statements from various campaign staffers stitched together, or from some policy paper put out by the urban institute in 2016. My complaint is the quality of the data for determining what the "Biden 401(k) proposal" actually is.

This might just be my impression, and maybe the administration has recently put out an actual policy proposal, in which case a link would be appreciated and you can ignore my rantings.

It's unclear to me if that 26% rate represents a reading of the tea leaves by the MSM, or if there was an actual clear statement by Biden on this.

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Re: Biden 401k - Taxed Twice?
« Reply #42 on: January 27, 2021, 11:50:13 AM »


Now I have the opposite problem. A 401a and a 403b and a 457b. More tax advantaged space than I could hope to fill.

The cruel irony of most gov jobs giving you this awesome park but paying low enough that makes it largely unattainable.

From the MPP thread

Would the proposed 401k reform make it possible to get 26% back on all three accounts?

seattlecyclone

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Re: Biden 401k - Taxed Twice?
« Reply #43 on: January 27, 2021, 02:08:38 PM »


Now I have the opposite problem. A 401a and a 403b and a 457b. More tax advantaged space than I could hope to fill.

The cruel irony of most gov jobs giving you this awesome park but paying low enough that makes it largely unattainable.

From the MPP thread

Would the proposed 401k reform make it possible to get 26% back on all three accounts?

That would be logical, and also there's no way to know until the detailed legislation is proposed.

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Re: Biden 401k - Taxed Twice?
« Reply #44 on: January 27, 2021, 04:02:47 PM »
This 401k change would double our AGI so we we lose out on the savers credit in its current form but the tax credits would more than make up for this.

The tax credits would exceed our tax liability since we max two 403b's, a 457B, two traditional IRA's, and HSA. Unless these credits were refundable we would have to switch to two Roth IRA's and a little in a Roth 403b to raise our tax liability to use the credits.

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Re: Biden 401k - Taxed Twice?
« Reply #45 on: January 27, 2021, 08:29:14 PM »
Ugh, this would be terrible for lower income families eligible for EITC!

The reduction in AGI thru payroll contributions to 401k reverses the phaseout of EITC (21% for more than one child).  Many states at least partially match EITC, too - my state matches at 30%, raising the effective phaseout rate to 27.3%.  Add on the federal tax bracket (10% with reduced AGI, 12% w/o) and state tax rate (4% with reduced AGI, 5.9% w/o) and you get a marginal rate of up to 45.2%.  So not only increased taxes, but reduced refundable credits (likely phased out altogether).

Let me guess - this is probably another nonrefundable credit, too, just like the nearly useless Retirement Saver's credit.  Or, at best, partially refundable, like the CTC or AOTC.  I've already got bunches of nonrefundable credits to burn, and no way to use them.  They get wasted every year.  But as soon as I'd like to use them to cover the taxes on Roth conversions, they will go poof and disappear.

Then there's other things that rely on AGI, like ACA subsidies, and FAFSA special conditions (SNT, auto EFC = 0).  Suddenly being unable to reduce our AGI thru 401k contributions would cost us many times this credit.

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Re: Biden 401k - Taxed Twice?
« Reply #46 on: January 27, 2021, 08:37:41 PM »
Let me guess - this is probably another nonrefundable credit, too, just like the nearly useless Retirement Saver's credit.  Or, at best, partially refundable, like the CTC or AOTC.  I've already got bunches of nonrefundable credits to burn, and no way to use them.  They get wasted every year.  But as soon as I'd like to use them to cover the taxes on Roth conversions, they will go poof and disappear.
I take it you didn't actually read the article:
"The credit could be refundable, meaning that workers who don't earn enough for the credit to offset their income tax liability would still receive the value."

Not that this means anything, as nothing has been officially proposed yet. In theory EITC thresholds could be adjusted as well to take into account the big change in possible deductions.

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Re: Biden 401k - Taxed Twice?
« Reply #47 on: January 29, 2021, 06:45:06 AM »
Say you contribute $10,000 now and you are in the 25% bracket.  You save $2500 on taxes, but you'll pay taxes when you withdraw.

Under Biden plan, you contribute after tax, so you'd have to earn $13,333, paying $3,333 in taxes, to contribute $10,000.  You'd then get a 26% tax credit for $2600.  So it looks like you made an extra $100, but really you paid an extra $733.

No, there is a $100 benefit in your scenario. Because you need to assume your income doesn't change both before and after. I'll use the 25% tax bracket assumption below even though that doesn't exist currently (22% and 24% are the closest brackets).

Current system:
$13,333 [marginal] income
-$10k 401k contribution
= $3,333 taxable * 0.25 = $833.25 tax

Biden tax credit change:
$13,333 income * 0.25 = $3,333.25 tax
$10k contribution * 0.26 = $2,600 credit
Final tax burden = 3333.25-2600 = $733.25

Yep, this is correct. This change might have other follow-on consequences though. Under current law your traditional 401(k) contributions are excluded from AGI. Under the new law they wouldn't be excluded, which would impact things like ACA subsidies and other tax credits. Many lower-income folks would be made better off by this change, but some (especially those who save a lot) might not.

The AGI is where the real action is.

For a single, low-AGI person, ACA coverage is approximately a 7-16% marginal tax.
The savers credit is affected by the AGI
State taxes are affected by the AGI

These are approximate numbers for a single person in California who makes 35,000 per year, takes the standard deduction, and makes a $10,000 401k contribution:

Existing scenario:
Federal tax: - $1295
State tax: - $93
Savers credit: + $200
ACA subsidy: + $3788

Net: + $2600

New Scenario:
Federal tax: - $2495
State tax: - $300
Savers credit: 0
ACA subsidy: + $2232
Federal credit: + $2600
Net: +$2097

So, the low-income saver loses about $500 from this change. We haven't even thought about the EITC or any state/local programs that low-AGI individuals might be eligible for.

Retireatee1

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Re: Biden 401k - Taxed Twice?
« Reply #48 on: January 29, 2021, 12:38:48 PM »
In addition to AGI, there is the MAGI used to determine eligibility for contributing to an IRA or Roth IRA.  Some who qualify now may no longer qualify if your 401K deductions bring you under the limit.  This is especially problematic for the Roth IRA because of the much higher limits and greater number of savers who exploit them.
« Last Edit: January 29, 2021, 02:11:36 PM by Retireatee1 »

seattlecyclone

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Re: Biden 401k - Taxed Twice?
« Reply #49 on: January 29, 2021, 01:00:19 PM »
When this gets to the stage of a concrete proposal before Congress the CBO will do an analysis of how much this is expected to affect revenues and expenditures going forward. If it turns out that this change will hurt low-income savers by kicking them off the other tax credits and things they've come to rely on, maybe they don't go ahead with it. My gut instinct is that the $35k earner saving $10k is very much an exception, and that the tax credit looks like an easy win for the $35k earner saving $2k, as would be more typical.