Change is in the air. With newly elected president Joe Biden finally in place, we can expect his administration to enact several changes throughout 2021. Because this will be a busy year for the new President, he probably won’t have time this year to implement tax re-reform legislation. So, what is at the forefront of Biden’s agenda? Re-imagining retirement plans like the 401(k) and rolling back the previous administration’s efforts to eliminate an Obama-era fiduciary rule governing the DOL will likely be addressed. If enacted, these two pieces of legislation carry concrete implications for Americans in every tax bracket. But going into 2021 with an idea of what to expect from Biden’s regulatory agenda will help investors make wiser choices regarding their retirement planning efforts.
401(k) Tax Deductions to be Replaced by a Tax Credit
It’s no secret; the way the system is currently set up gives a definitive advantage to families that earn higher incomes. It’s not because they have more money to contribute to their retirement plans though. It’s because of how 401(k)s work in regard to tax rates.
Contributing to a 401(k) gives the investor a tax deduction. The money that you put into that account is pre-tax, meaning you don’t pay taxes on it until you withdraw money from the account. By contributing to your 401(k) under the current rules, you directly lower your taxable income. The deduction’s amount is not equal across every tax bracket, however. The higher your income, the greater the tax deduction benefit. Take the following scenario for example:
A single income household bringing in $100,000 per year would fall into the 24% income tax bracket. If they contributed 10% of their annual salary to their 401(k) under the current rules, they’d get a $2,400 deduction. A person making $35,000 a year would only be in the 12% tax bracket. Contributing 10% of their income yields a $420 deduction. Under the current system, the lower your yearly income, the less tax incentive there is for you to contribute to your 401(k), unless your plan has a Roth 401k provision.
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Biden’s new plan, however, would flip the current system on its head by converting the tax deduction into a tax credit of 26%. While the resulting credit would be less than the deduction for people in higher income brackets, it would significantly impact contributors with lower salaries. In the above example, the person making $35,000 would receive a $910 credit rather than a $420 deduction.
The plan’s goal is to remove some roadblocks to saving, roadblocks that are more prevalent for working-class families stuck in lower income —and tax— brackets, while driving high-end earners towards alternative financial products like Roth IRAs.
Expanding 401(k) Access
Biden’s proposed changes do more than address inequalities inherent to the current retirement savings landscape; they also seek to extend 401(k) access to a much wider range of people. It is no secret that a large portion of Americans are behind the eight-ball so to speak when it comes to their retirement efforts. According to Investopedia, a staggering 48% of people 55 and older have no tangible savings. Even worse, 37% of those with retirement accounts don’t understand how those accounts work, even on an elemental basis.
In short, aging Americans are headed towards retirement massively underfunded. In order to stem this rapidly growing crisis, the Biden administration has proposed a new state-run, automatically enrolled 401(k) program. So far, the details are sparse, but overall, the piece of legislation aims to expand access to retirement savings accounts for employees whose employers don’t offer retirement options.
One element that the Biden administration is concerned with is the increasing number of caregivers not participating in the workforce. These are workers who’ve left traditional employment to take care of family members and loved ones. Because these individuals don’t have earned income, they are no longer eligible to contribute to their existing 401(k) plans. Biden’s legislation gives this increasing demographic the option of making “catch-up” payments to help ensure that everyone has access to long-term financial planning.
The New DOL Fiduciary Rule
The other half of the equation revolves around Biden’s stance on how financial professionals are allowed to treat clients’ investments.
In 2016, the Obama administration drafted a new rule that required all financial professionals who service retirement accounts to act as fiduciaries. This rule greatly expanded upon the core definition of “fiduciary”. It made certain types of “broker” compensation a prohibited transaction but then included an “exemption” to the prohibition that brokers felt was far to onerous. The rule required brokers to be held to the same “fiduciary standard” Registered Investment Advisors (RIA’s) were held to. The bottom line? All kinds of financial advisors must put their clients’ financial interests above their own.
However, before it was to become effective, the 5th circuit struck down the regulation altogether leaving investors potentially unprotected. The Trump administration’s DOL attempted to work along with the Securities and Exchange Commission (SEC) to draft a compromise. They reinstated the “5-part rule” allowing brokers a loophole to avoid being a fiduciary, while still having to adhere to the SEC’s “Regulation Best Interest.” This rule was considerably less stringent than the original proposed Obama DOL rule, and the Trump revision is set to be put into effect this year.
Prior to the election, Democrats emphatically stated their objection to the rule and the party’s intention to reverse it should Biden win. Now that he is in office, the president appears ready to make good on that promise by nominating Bostonian Mayor Martin Walsh as Secretary of Labor. Walsh’s presence alone marks a profound shift in DOL philosophy; he has deep roots in the Laborers’ Union and will be the first appointee in over 50 years with a history of directly fighting for workers’ rights with boots on the ground. Under his oversight, it is a good bet that the final rule drafted during the Trump era will be vacated altogether and new safeguards will be put into place to protect retirement account holders. These safeguards will be similar to those proposed back during the Obama administration.
The Winds of (Fiduciary) Change
Regardless of the minutiae, expect rapid and meaningful change to take hold in 2021. Joe Biden has made clear his intention to give families with lower incomes the tools —and protections— necessary to save money and build their own personal wealth. With a Democratic congress behind him, it’s a good bet that he will succeed.
This information is not intended as authoritative guidance or tax or legal advice.