President Joe Biden’s 2022 budget proposal raises the top income tax rate up to 39.6%. Taxpayers with an adjusted gross income over $1 million will also have to pay this rate on long-term capital gains and qualified dividends. But while the president’s tax hike could compel high-income investors to move their money into tax-exempt retirement accounts like Roth IRAs, it could also benefit tax-deferred retirement plans like 401(k)s for low- and middle-class taxpayers. A financial advisor can help provide expert advise on which strategies make most sense for your finances. Let’s break down how Biden’s tax increases could affect your retirement plans.
How Biden’s Tax Plan Affects Retirement Accounts
Benjamin Franklin says that death and taxes are inevitable. But for many high-income Americans facing Biden’s proposed tax hikes, choosing when to pay taxes is crucial to maximizing their investments.
Biden’s 2022 budget proposal is driving attention to tax-advantaged retirement accounts like Roth IRAs and 401(k)s as an alternative strategy to mitigate capital gains tax increases and grow capital through tax-free or tax-deferred investments.
As an example, investors who move money into a Roth IRA, will have to pay taxes up-front, but could make tax-free withdrawals as long as they are age 59.5 or older and hold the account for more than five years. So if Biden’s capital gains tax hike gets approved, high-income investors could save money by paying a lower rate now.
Comparatively, investors moving money into tax-deferred retirement accounts like 401(k)s, will be able to postpone paying taxes on the money they invest until withdrawal. This means that they have more flexibility on how much in taxes they will have to pay by limiting the amount they take out to keep their income beneath the top tax rate.
Biden’s tax hikes aim to raise revenue for his Build Back Better agenda, which is made up of the approved American Rescue Plan, and the proposed American Jobs Plan and American Families Plan. Combined, these plans cost more than $6 trillion.
The 2022 budget proposal says that it will reform the tax code to improve its administration and make the system more equitable and efficient.
For corporations, this means rolling back President Donald Trump’s 2017 Tax plan, which set a 21% flat tax for all businesses, and raising it up to 28%. Biden will also apply a minimum 15% tax on corporate book earnings (the income that is used to report profits to investors).
And for high-income individuals and families, Biden’s 39.6% top income tax rate (which will be applied to long-term capital gains over $1 million) will reduce their income from the sale of assets. But this proposed tax hike could also affect low- and middle-class taxpayers.
The 2022 budget proposal estimates that the 28% corporate tax rate will bring in almost $858 billion in revenue by 2031, as well as more than $148 billion from the 15% corporate book earnings tax and roughly $322 billion from the capital gains tax increase during the same period.
How Biden’s Tax Plan Affects Ordinary Taxpayers
While Biden’s budget proposal may target mostly high-income taxpayers, the finances of low- and middle-income Americans could also be impacted in different ways. As an example, if the tax hikes trigger a stock market sell-off (this happens when traders make a lot of quick sales), the value of their retirement portfolio could change.
For reference, the financial services company Fidelity says that the average balance for defined-contribution plans like 401(k)s or 403(b)s in the first quarter of 2021 was $123,900, almost twice as much as the average balance in 2011 (which was $72,800).
In 2018, the finance services company says that the average 401(k) balance was $95,600, with investors nationwide contributing 9% of their income. For a wider comparison, the table below breaks down contribution rates and balances by age group. Data was compiled by Fidelity Investments from 22,600 corporate defined contribution plans and 16.4 million participants.
401(k) Contribution Rates and Balances by Age
|Age Range||Average Account Balance||Average Contribution Rate|
|20 to 29||$10,500||7% of income|
|30 to 39||$38,400||8% of income|
|40 to 49||$93,400||8% of income|
|50 to 59||$160,000||10% of income|
|60 to 69||$182,100||11% of income|
|70 to 79||$171,400||12% to income|
Fidelity’s president of workplace investing, Kevin Barry, said in a related press release that “the stock market’s recent performance provided a boost to retirement savings balances.” And while investors cannot control the performance of the stock market, Barry explained that they can control how much they save into their retirement accounts. Financial advisors agree that long-term savings could help investors withstand stock market changes and reach their retirement goals.
It’s also worth noting that Biden’s capital gains tax proposal could also impact low- and middle-income homeowners in hot housing markets. The IRS considers homes as capital assets, and single and joint tax filers are exempt from paying capital gains taxes on the first $250,000 and $500,000 of a sale respectively. Owners must live in the home at least two years out of the past five years before the sale date to qualify. But home sales in hot markets could now elevate sellers over Biden’s proposed $1 million threshold.
How Retirement Accounts Can Reduce Taxable Income
Biden’s budget proposal has made tax-exempt accounts like Roth IRAs more attractive for high-income investors. As we already explained, Roth IRA holders have to pay taxes up-front. However, they can make withdrawals tax-free as long as they meet account requirements. And this strategy can pay off if Biden’s tax hike gets approved.
High-income taxpayers should note that Roth IRAs have income limits that exclude them from contributing (only individuals making less than $153,000 in 2023 and joint filers under $228,000 are eligible). But the IRS allows them to move money from traditional IRAs or 401(k)s to Roth IRAs through a conversion.
IRAs can also benefit low- and middle-income taxpayers. Traditional IRAs, unlike Roth IRAs, are tax deductible. This means that when you put money into a traditional individual retirement account you can reduce your taxable income. As an example, individuals in the 12% tax bracket (earning between $9,951 and $40,525) can deduct $12 for every $100 saved in their account.
Currently, traditional IRA deductions go up for individuals in higher brackets. For a comparison, those in the 24% bracket (earning between $86,376 and $164,925) can deduct $24 for every $100 saved in their account and taxpayers in the top 37% bracket (making over $523,601) can deduct $37 for every $100 saved in their account.
You should note, however, that the IRS limits how much you can invest in an IRA. For tax year 2023, the agency limits contributions up to $6,500 (and $7,500 for those age 50 and over). And this limit applies to the total of all your IRAs.
Comparatively, the agency allows employees to contribute up to $20,500 to their 401(k) plans in tax year 2022 and $22,500 in tax year 2023. And just like with an IRA, if you are age 50 and older, you can also make an additional catch-up contribution of $6,500 for a total of $26,500 for tax year 2022 and $29,000 for tax year 2023.
The table below breaks down tax savings based on 10% contributions to 401(k)s for single and joint tax filers.
401(k) Tax Savings for Single and Joint Filers
|Single Income||Tax Savings Based on 10% Contributions||Joint Income||Tax Savings Based on 10% Contributions|
|*Tax savings are based on 2021 Federal Income Tax rates and brackets.|
As you can see above, those in lower income brackets save substantially less on taxes than those in higher income brackets. A single taxpayer earning $40,000 in tax year 2022 and contributing 10% to a 401(k) plan will save 1.2% of their income or $480 in taxes. Comparably, a single filer earning $120,000 that same tax year and contributing 10% will save twice as much (2.4% or $2,880).
Experts say that Biden could propose a standardized retirement tax credit that gives all taxpayers (regardless of income) an equal tax break. If passed, this would replace the current deductions that you can get when investing in your 401(k) plan.
During the 2020 presidential campaign, Biden promised to “equalize benefits across the income scale” so that lower income families could get substantial tax benefits for retirement.
Treasury Secretary Janet Yellen has also supported the president’s campaign promise to incentivize lower income retirement savings. “There are many possible options for making retirement contributions more generous to middle-income families,” she said at a Senate hearing.
President Joe Biden’s 2022 budget proposal will raise the top income tax rate up to 39.6% and double capital gains taxes for investors making over $1 million. While the president’s tax hike could compel high-income investors to move their money into tax-exempt retirement accounts like Roth IRAs, it could also benefit tax-deferred retirement plans like 401(k)s for low- and middle-class taxpayers. Biden’s plan will change as it moves through Congress, and both chambers will have to approve it via vote before the president can sign it into law.
Tips for Lowering Taxes
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