Tax reform is a game of musical chairs that will hurt your 401(k)

Tax reform is a game of musical chairs that will hurt your 401(k)
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During the 2016 campaign, Donald TrumpDonald John TrumpO’Malley tells Dems not to fear Trump Right way and wrong way Five things to know about the elephant trophies controversy MORE promised tax cuts. Today, he unveiled them. Yet regardless of those cuts, the IRS still must generate the same amount of revenues in order to avoid a deficit. So, instead of seeing tax cuts, we’ll see tax reform. Once the Danse Macabre music stops playing and everyone has claimed their chair, many Americans will be left standing, chairless and all.

How tax cuts became tax reform

Republicans aim to pass a tax bill by reconciliation, rather than by negotiation with Democrats. This requires the bill to be deficit neutral, meaning the GOP needs a tax reform bill that will generate some revenues in the short-term rather than implementing real tax cuts.

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Among other reforms, the GOP considers taxing 401(k) contributions upfront. This idea traces its roots to 2014, when Rep. Dave Camp (R-Mich.) created a proposal that would tax 401(k) contributions if they exceeded half of the annual limit. The current proposed reform would tax contributions in their entirety.

With 55 million active participants, these retirement accounts are the most popular retirement savings vehicles. Currently, more than $5 trillion in assets are stored in 401(k) plans. And the result? A tax reform plan that generates $144 billion in revenues over the next 10 years.

One of the primary advantages of 401(k) plans is deferred taxation. Participants pay taxes on contributions only once they have retired and dropped to a lower tax bracket. This measure would tax plan participants at the time of contribution, while in a higher tax bracket. This would measurably reduce the amount of income available for investment and savings.

What comes after tax reform

Plan participants could find themselves forced to transfer their savings to a Roth plan, which means they would have to pay a lump sum to the IRS. With the government desperately trying to generate revenues, seizing or heavily taxing retirement funds might become a possibility. This has occurred in countries like Ireland, Hungary, Argentina and France.

Another model? President Obama's near-defunct myRA initiative initiative. These individual retirement accounts were sponsored by the government and allowed Americans to invest in Treasury securities funds. The initiative is now closed due to low demand, but the government may decide to revive this model to plant its avaricious hands on the retirement savings.

Tax reform impact on retirees

In a world where lack of job security and low wage growth are realities, 401(k) retirement plans were already fragile. The need for an accessible retirement savings vehicle is stronger than ever, with 65-year-olds being five times more likely to reach the age of 85 than they were 100 years ago.

While 83 percent of private sector employees could count on a pension plan in 1989, defined contribution plans are the new norm and will be the primary source of income for the next generation of retirees. The high cost of living, increased life expectancy and now possible increased taxation on contribution will make retirement even more difficult.

Additionally, this tax reform would make 401(k) plans even less accessible for those behind on their retirement savings. An additional $6 trillion to $14 trillion in retirement savings would be needed to prevent a retirement crisis in the United States. This reform will make catching up all but impossible.

Savers are not rewarded in tax reform

The government is clearly not intent on rewarding those who are doing the right thing by putting money aside for their futures and the futures of their families. Instead of the promised tax cuts, the GOP is playing a dangerous game of musical chairs that will deleteriously impact retirees in the future, all for the sake of passing a deficit-neutral tax bill.

By pushing taxation on 401(k) contributions, Republicans are doing the opposite of what could drive growth. Increasing savings by only 2.5 percent would result in an increase in GDP per capita of $3,500 by 2040. It is likely that increasing upfront taxation on retirement savings will have the inverse effect on per capita GDP. With President Trump announcing his plan today, it appears change will likely come sooner than later.

Chris Markowski (@ChrisMarko) is an author, investment banker, stock market analyst and consumer advocate. He is the personality behind Watchdog on Wall Street and the founder of Markowski Investments.