The Republicans are proposing massive tax cuts, including a 15-point decrease in the Corporate tax rate from 35 down to 20, in their new tax code “reform” bill. But to do so, they need to at least have the veneer of those tax cuts being paid for.
There have been a few proposals to do this, but one that has gained steam in the Senate is what is euphemistically being called “Rothization.” In short order, this means capping the amount of pre-tax money you’re allowed to invest in your 401k. You can invest more, but that money will be taxable.
Trump, in his predictably self-harming way, has thrown cold water on this idea. But Trump being Trump, that’s far from saying the idea is dead. So what is Rothization? Like everything else about taxes and tax policy, it’s goddamned confusing. Here’s the basics as I see them:
What is Rothization?
What this really means is a cap on the amount of pre-tax deduction a private individual can invest in their 401k. The cap has been proposed at $2,400. After you’ve invested that $2,400, the rest of your 401k money would move into an investment that is called a Roth IRA. Roth IRAs are investments of post-tax money, meaning you’ll be paying taxes on anything above $2,400. The advantage of Roth IRAs, such as they are, is that when it comes time to withdraw your money, you won’t be required to pay taxes on it.
That doesn’t sound bad to me?
It’s not. Roth IRAs are an excellent investment tool if you have the money to contribute to your retirement above and beyond what your 401k will produce. But they’re not a substitute for 401k investments.
So… what’s the problem?
401k was created specifically to incentivize investment in our futures. By making contributions tax-exempt, 401k investments can reduce your taxable income quite a bit, making them an excellent way to both save for the future and also provide a short-term gain for your family’s pocketbook. Taking this tax incentive away deincentivizes investment and raises your taxes. It’s a double hit on your economic health.
This is a very-specifically targeted Middle Class tax hike
Actually, if your employer matches at 5% and you make 30k a year, you’ll only invest about $1,500 a year. You’re fine.
But if you’re in the middle of our tax brackets, this is going to hit you hard. Anyone making over $48k and contributing at 5% is going to see a tax increase. If you’ve been aggressive until now about saving for retirement, investing more than your employer’s match, you’ll see an even bigger tax increase.
Also, it’s unclear if this $2,400 cap holds for dual-income families. If so, even lower-income families could see a tax hike.
This disincentivizes retirement investment
I guess I thought Republicans were always scolding me about not investing my income. I guess I always thought I heard them justify tax cuts because they “could be invested.” But now, Republicans are telling us that, in order to pay for a corporate tax rate cut, we’re going to need to either invest less or pay more taxes. We have those two choices, under their tax plan. That doesn’t seem like a very good deal to me.