Fiduciary Is Fun!
(a.k.a. I heart taxes)
(a.k.a. I heart taxes)
At first, it doesn’t seem as if this title makes too much sense. Afterall, 401k plans are tax advantaged vehicles and only file informational tax returns. There is no tax owed by a qualified retirement plan. And this is certainly technically correct.
However, most plans now have Roth features which allow employees to have their deferrals taxed prior to them being deposited into the plan. The advantage to Roth is that even though the deferrals are taxed initially, all future earnings on those deferrals can be withdrawn (with a few minor restrictions) tax free by the employee. Pretty niffy. Even so, the vast majority of 401k deferrals (and 403b deferrals) are pretax, meaning that employees will pay ordinary income tax on the deferrals AND all earnings when they withdraw those funds.
So tax planning for your retirement plan is really more of an employee issue versus an employer issue, and what a planning opportunity it is! I am working with one of my clients now in anticipation of conducting employee meetings in early January to focus specifically on this issue.
Some details: After the passage of the Tax Cut and Jobs Act in late 2017, the marginal tax rates for most Americans dropped. The marginal rate is only 12% for a married couple earning no more than $78,950, and it only increases to 22% if that couple earns no more than $168,400. That covers a lot of young couples in this country! In fact, my client has the majority of their employees under 30 and earning around $40,000. Most are basically in the 12% marginal bracket. Is it worth getting the traditional 401k tax break for deferrals for such a group? I would argue NO.
People tend to think Roth or no-Roth and leave it at that. I believe there are some pretty compelling arguments to be made that when employees are early in their career and earnings are more modest that Roth makes absolutely good sense. Later in their career when they might be in the 35% or 37% tax bracket, if they are so fortunate, then traditional 401k deferrals might make sense. You can always change!
So what makes the most sense for your employees? What are you advising them as you enter into a new year? Just as importantly, what is your advisor saying? And does your advisor have the skill set to even make such recommendations?
If you would like an additional perspective and some thoughts on how to position your employees for long term financial success, give me a call. I would love to visit about optimizing tax benefits. Just the thought makes me warm all over!
Pete Welsh a/k/a 401kGuy