401(k) Interrupted: Suspend Contributions While You Wait For Trump’s Tax Cuts?
Ashlea Ebeling, Forbes Staff, I write about how to build, manage and enjoy your family’s wealth.
This story appears in the January 24, 2017 issue of Forbes. (Credit: Robert Babboni for Forbes)
Here’s a heretical idea: Suspend contributions to your 401(k) in early 2017 while you wait to see how much President Trump and the Republican-controlled Congress cut income tax rates and how they revamp the tax code. This advice is meant for high earners who max out their allowed 401(k) contributions, possibly early in the year. (In other words, it’s not for average workers struggling to save 5% of each paycheck.)
Say you’re earning $500,000 and years ago elected to contribute 10% of your salary, pretax, to your 401(k). In 2017, as in 2016, the legal dollar maximum for employee pretax contributions is $18,000 for younger folks and $24,000 for those 50 or older. So you’ll reach that deferral limit in May or June.
But depending on how deeply rates are cut and the state and local income taxes where you live and plan to retire, you might be better off using some or all of that $18,000/$24,000 allotment to fund a Roth 401(k)–an option now available in about 60% of larger plans, according to benefits consultant Aon Hewitt. Or, if you aren’t offered a Roth, you might decide to put less in your 401(k) and more in a taxable brokerage account.
“I’d hang back and wait and see what happens on tax rates,” says Robert Gordon, president of Twenty-First Securities in New York. “Until you know what the story is, you can’t make an informed decision on it.”
Warning: Before you pause 401(k) contributions, make sure you won’t forfeit any of your employer’s match. A majority of companies allow you to stuff money into your 401(k) late in the year and capture the full match. But a third require you to contribute each paycheck to snag the full amount, Aon Hewitt reports.
If the employer match isn’t a problem, here are three other issues to consider. First is your tax rate now versus what you guess it will be in retirement. You get no tax deduction for contributing to a Roth, but all withdrawals in retirement are tax-free and you aren’t forced to start taking money out when you turn 70 1/2, as you must from a pretax account. If your overall tax rate will be the same or higher in retirement, a Roth has the edge. But if, for example, you live in high-tax California or New York City now and plan to retire to income-tax-free Florida or Nevada, your combined rate will likely go down. So you should grab your deductions now.
The second factor: Congress is fickle and future tax rates unknowable. Hedge your bets, building up separate pretax, Roth and regular taxable savings. “It’s tax diversification,” explains Robert Keebler, a CPA in Green Bay, Wisconsin. The top federal income tax rate on salary is now 39.6%, and Trump wants to cut it to 33%. If he succeeds, consider it a window to build up your Roth stash, not a forever promise.