The Republican proposal to cap contributions to traditional tax-deferred 401(k) plans isn’t dead yet. Republicans will need to find revenue from somewhere if they want to enact broad tax cuts while still complying with the terms of the budget resolution that the Senate already passed and the House is set to approve today. The resolution allows for tax cuts that add $1.5 trillion to the national debt over the next 10 years, but the GOP tax plan in its current form loses somewhere in the range of $2.4 trillion, and Republicans need to fill that gap. One way they might do so is by capping contributions to traditional 401(k) plans at $2,400 per year and requiring that contributions above that amount go into Roth accounts.
This post argues that Republicans can include Rothification as part of their tax reform package while preserving one of the more attractive features of traditional 401(k) plans: taxation of withdrawals at the taxpayer’s marginal rate in the year of withdrawal. That might on first glance seem impossible: After all, a core feature of Roth plans is that taxpayers pay at their regular rates in the year of contribution and then can withdraw years later tax-free. By contrast, in a traditional plan, taxpayers pay no tax on contributions when made and then include withdrawals in their taxable income for the withdrawal year. But as I’ll argue, Republicans can achieve the basic benefits of Rothification while also maintaining the rate attribute of traditional plans — albeit with an element of complexity that might make the game not worth the candle. [Disclaimer: None of this is to suggest that 401(k) plans — Roth or traditional — are a first-best policy for encouraging retirement savings, as I think they’re almost certainly not.]
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