Transcription: Segment 1
Paul Winkler: Hey, welcome to the Investor Coaching Show. So we have lots of topics. This is Evan partnered here with me and Arlene Brown. Arlene, how are you doing? It was wonderful to see you showing pictures of those grandkids before hand.
Arlene Brown: He is five years old, and we took him to the zoo. It’s really interesting, at least now a lot of people are going outside, and kids are all wearing masks.
Paul: Are the monkeys wearing them? Just asking for a friend.
Somebody was telling me this week, they were talking about their family and different people in their family and what they did for a living, and I thought it was fascinating. One of them went into that, working in zoos, and that’s just so different from the rest of the family, the rest of the family are doctors. Being in the medical field and working in law, or all of these desk types of jobs and one child and the family says, “No, I’m going to go work in the zoo, man. That’s what I’m doing.” He’d had enough of his crazy family.
Possible changes to retirement savings
So one of the things that I want to talk about this week here, you guys probably saw this, “Joe Biden promises to end traditional 401(k)-style retirement savings benefits.” What do you think about that?
What’s that mean? So this was Forbes magazine. It means our clients are going to get more emails about the 401(k). “It’s going away and getting stolen by the governments,” that’s what it means. Yeah. Well, the last time that happened, the perpetrator actually had to hire a bodyguard. It didn’t end well for that person.
Arlene: He was saying, is that a flat tax?
Paul: Yeah. Give me an example.
Arlene: Well, let’s say Evan is making $600,000 and I am making $60,000. So if every thousand dollars, because he is in the 37% tax bracket. So for every $1,000 he put into 401(k), he would get a $370 tax credit. Okay. While I am, because I am making $60,000, I am in a 22% bracket.
Okay. So I am only getting 22%, then it’s $220 tax credit. But they are looking at it from that lens, the inequality, basically.
Paul: What I’m gathering from everything that I’m seeing regarding this is it would make this way more disadvantageous for higher income people.
Arlene: Yes. Basically, because that’s what they’re saying. It has to be that incentive to incentivize lower income people. Okay. But the purpose really for a 401(k) is really this: the tax difference of the growth.
Paul: They say that they’re going to take away the tax deferral of the growth is that it?
Arlene: That is not clear about that. It seems like that is what it says, but it doesn’t really.
Would anybody even bother to offer a 401(k)?
Paul: On future contributions, anything that is ever changed has always been grandfathered in. But here’s the thing that I’m looking at. Okay. So if you say, what we’re going to do is we’re going to change the 401(k) and we’re going to make it less advantageous for upper income people. The people that actually own the companies that started the 401(k) that pay the third-party administrator and pay the expenses. Then the question is, would anybody even bother offering a 401(k) anymore? Because why do people do things for their own reasons? And they don’t mind, a business owner doesn’t mind putting such a plan in place if they get to benefit from the plan.
Arlene: If it’s, say, a 20% flat tax like they’re suggesting, okay. So if 20%, those who are under the 20% tax bracket, there’s no point of saving.
Paul: Okay. So when you say 20% tax rate tax. So typically what happens is I’ve got a thousand dollars and I put money in. I’m in a 10% tax bracket. Then instead of paying a $100 in taxes, I get tax credits. Then I can get the whole thousand dollars. Then it goes into an investment vehicle. If I’m in a 22% tax bracket, $220 is what I save in taxes right now, full thousand dollars goes in there.
I missed what you were saying because of the echo that I was dealing with here. When you said the 20% rate, what does that apply to again?
Arlene: The taxes that you’ve paid, if it is the flat tax credit.
Paul: So if I put a thousand dollars in, you are going to give me $200 of that? And it’s the same effect. How much might it go in the plan, is what I’m trying to get at. Yeah. I’m still confused and I’m in this business, but it was a very unclear article. I don’t get what they’re saying. A tax credit to me is, you’re going to take $200 off my taxes. If I make a thousand dollars contribution. That’s right. You’re going to take $200. So it has the same effect as $200. It’s a wash, a tax deduction. Yes
Arlene: You are. But if you are in a higher tax bracket.
Paul: Right. You still only get 20%. You still get that. Okay. All right. I’m getting it. But do you pay taxes on all of the distribution and the back end, that upper income person? Do you just pay all the taxes on it?
Arlene: Yes. And it’s the contribution that they are talking about. That’s what they they are missing. It’s the distribution that gets taxed, too, because it doesn’t matter if it’s going to be taxed anyway.
Paul: So the distribution is going to be taxed down the road. Yeah. No tax and whatever your margin rate is. So let me put this in numbers. So people understand what the heck we’re talking about, because this is like probably giving people haircuts around Nashville. So if I put a thousand dollars in and I get a $200 tax credit, so to speak, so it’s kind of like, I get this 20% benefit, but later on, I pull the money out and there’s a 40% tax let’s say, then in essence, a thousand dollars becomes where it would have become $800.
If I had paid, the 20% in taxes now becomes $600. So I have an $800 down to $600. I have a loss in essence, because of the differential between what the credit was versus what the taxes on the back end am I getting? Okay, cool.
Arlene: But what I am also saying is that if I am a low in the lower tax bracket, right. Okay. So if I am in a 10% tax bracket and I’m getting 20% tax credit. Okay. Then it seems like what’s the purpose?
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What’s the purpose?
Paul: Why what’s the purpose? Well, I think the point would be just like it is right now, where you have $200 and then when you pull the money back out later on, you only have a 10% tax rate. And I’m just, you’re making an assumption of an account that doesn’t grow just to make it simple for people, a thousand dollars. Now it’s a thousand dollars down in the future. Cause you were a lousy investor and you couldn’t grow the money at all. And you end up with a thousand dollars, but then you pay taxes at a 10% rate. You’ve got $900 to spend. You basically would have had if you’re well.
My tax bracket of 20%, I would have had $800. I get basically a tax credit of $800. That’s a pretty good deal. I would think because it’s like getting a 20% tax deduction now. So you get an increase in the tax and it would have been a hundred dollars because your tax rate right now is 10%. If you’re really low income versus going to be 20%. And then 10% is what you avoid later on. It seems like a good deal to me, but here’s the problem: who on earth in their right mind would set up a 401(k) plan and go through all of the expense and all the challenge and all the headache?
If they, as the owner of the business, don’t benefit from it, number one. Number two, if they don’t do that, you don’t have to pay matches. If you don’t have a 401(k), you don’t have to make matches. Now you can make the point that the employer being a nice fair person would say, “Hey, you know, the money that we were matching, where we’re going to do is we’re going to go and put that in your paycheck.” Now you have another problem on your hands. People get money in their paycheck. What do they do with it? They go to Krispy Kreme, crispy green.
They spend the money, and then we’re down the road. We have this problem because we don’t have people with any money and they can’t retire because they’ve got no money. And now you have another problem in that people don’t have any money in retirement. And now we have an incentive, or the government has driven to somehow figure out ways of getting more tax revenue, either by national sales taxes, which hurt everybody or higher marginal rates or something like, because they were talking about that, how many people don’t. And this blew me away in this article.
401(k) savings statistics
I thought this was interesting people with 401(k)s. How many people with matches their employer has a match? How many don’t bother saving money for retirement or putting money in at all? 34% of savers contribute less than needed to get the full match. 18% only contributed up to get the match and no more than that. And they thought it was surprising. I thought it was funny in the article that a surprising 49% contribute more than the matches.
Doesn’t exactly add up, but it’s close. Must’ve been a rounding error, but interesting to me that people just don’t take advantage of the matches right now. And if you’re going to give a tax credit, we already have a savers tax credit, right. So my guess is they’re kind of, my guess is I haven’t read through the plan to get rid of the saver’s credit and they’ll just give people a flat tax flat benefit.
Yeah. And that will be the same as say, getting a 10% deduction and a 10% saver’s credit on top of that, my guess is where that 20% is coming from. But I don’t know, Oh, the savers credit, it’s equal to 50% of the first $2,000 in retirement savings. So you get a tax credit, which is kind of like this, the system that’s being proposed. But if I put $2,000 in the government gives me a thousand bucks. So it’s like, they’re giving me a hundred percent match on my contribution.
Is that a way of looking at it? I can’t remember the max on that credit though. It’s $2000. Okay. And then if you’re for lower income earners up to $19,500 for singles, $39,000 for couples phasing out to 20%, 10%, ultimately nothing for singles with $32,500. And then there’s like $65,000 income stay at. It’s just crazy, let me just put it this way. It is a tax credit that is what is being proposed, but it is for lower income people.
Automatic enrollment
And I just wonder, I don’t know, I’ve never seen the statistics on this, but I don’t know that many people that actually even take advantage of that. I remember when my income was super, super low. Well, shoot. I’m trying to think back before I was a financial planner. What I did, my income was low before my income was a, the first 10 years of being a financial wait. That’s a different story, but I saved as you know, I knew that I needed to save, right.
But before I was in the financial business, I was working for a computer company and did for a while until the whole time I was in college and made a decent income, actually higher income than I made as a financial planner for my first 10 years, took a pay cut. It was crazy. But did I even think about saving for the future at that point in time. And the answer was, now I didn’t save. And it was just because there was always something more compelling. So I wonder how, like a heating bill, paying the rent or whatever.
But here’s the issue that I see: a lot of these people, this credit already exists and you’re trying to say, “Hey, let’s change the whole system to something that people aren’t using now.” Right. And I don’t know that that is a really good idea. And those percentages you read, I’m going to guess, include the fact that a lot of plans have automatic enrollment or those numbers would probably be a lot lower across the board.
The automatic enrollment has been significantly helping out in terms of people actually participating. In the other words, you are basically enrolled, unless you say differently. And most people won’t put forth the effort to disenroll in a 401(k) plan. So it’s interesting. We’re going to take a quick break. You’re listening to the Investor Coaching Show, and here’s the thing, the bottom line on this segment and what I want to just point out to you. I don’t want to sit here and say, “Oh my goodness, this new proposal of buying GE gets in your 401(k) is going to be taken away.
And all of that simply because this has been something that’s been talked about for many, many years. And people that have talked about taking away the 401(k). I’m not kidding. Literally, I was not joking, and had to hire bodyguards. It is not something that goes over really big with the American public. So don’t worry about it from that standpoint, but I would know about it and be familiar with it and be aware of it because it can actually inform the rest of your financial planning when you have to think about taxes and how to plan for the future and what might be the changes that take place.
It might be something that, Hey, if we have a change in leadership, then we might have to be thinking in terms of changing how we do deductibility of investment contributions in the future versus Roth contributions, not non-qualified plans, how they fit in everything.
You’re listening to the Investor Coaching Show. I’m Paul Winkler, along with Evan Barnard and Arlene Brown.
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