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How Can Fiduciaries Use New Tax Cuts to Nudge 401k and IRA Retirement Savers?

How Can Fiduciaries Use New Tax Cuts to Nudge 401k and IRA Retirement Savers?
January 03
00:57 2018

The new tax law is in the books and some are saying workers will begin to see the benefits as early as February. With the average taxpayer saving $2,000 a year, the coming tax cuts may offer an opportunity for workers to retire in greater comfort – but only if they make forward-thinking decisions. Plan fiduciaries and financial professionals have only weeks to prepare retirement savers. Of course, the more astute saver will already know what to do. Here’s what they might consider.

The average worker will no doubt want to know how the new tax law will affect them. “The most immediate impact for the average worker will be seen on their paychecks,” says Avo Mavilian, President at Tailwind Financial Strategies, LLC in Houston, Texas. “Assuming they earn the same amount as last year and that pre-tax deductions for health insurance and other withholdings remain the same, their take-home dollars should be higher.”

The exact timing of this increase in their paycheck depends on a number of factors. Ted Jenkin, CEO of oXYGen Financial in Atlanta, Georgia, says, “When the IRS changes the tax tables in Mid-February/Early March, Americans will see the bump in the lower tax brackets at that time.”

Of course, that might not stop companies from spreading the wealth right away. As we’ve seen just prior to Christmas, large companies like AT&T, Boeing, and Comcast (to name a few) announced $1,000 bonuses or other employee benefits specifically as a result of the new tax bill. There are more ways to help employees. “Savings should begin as soon as the first paycheck in 2018 if your HR department has adjusted withholdings for the new tax law,” says Jeff P. Vogan, President/CEO of Premiere Retirement Planning & Wealth Management in Tucson, Arizona. “The average worker making less than $100K per year could see savings in the range of $1,000 to $4,000 per year. That could be spent on necessities that have been deferred a while, or put away and saved. People naturally have the inclination to spend the extra money, so saving it for retirement may take some work and a little discipline.”

The new tax law doesn’t just provide an opportunity to save more in retirement plans, it also may change the preferred method of retirement saving. “The obvious impact is that employees will be able to save more money into their retirement accounts without lowering their existing take home pay,” says Jairo Gomez, Director of Retirement Plans at Hanson McClain Advisors, in Sacramento, California. “However, with the lowering of the tax bracket for some with higher incomes, the Roth feature may become more appealing, as a deduction may not be as big of a necessity as in the past. The IRS is working on the withholding tables, but probably will not be reflected in paychecks until February 2018 at the earliest.”

Employees saving through 401k plans don’t have to wait until February to act. Indeed, it may be better for them to act in advance of the IRS or their HR department. Jenkin suggests employees “immediately increase your 401k savings by the 1 to 2% change there will be in the tax brackets now, so when the change hits in a month, you don’t miss the money.”

This proactive decision eliminates a much tougher decision (and even tougher temptation) later on. “The easiest way to not see the funds in your bank account or to be tempted to spend the excess on non-essentials is to merely tell the HR department to withhold an additional amount equal to your tax savings from each paycheck and apply it to your 401k,” says Vogan. “You will still get your deduction on what you put away so that is still a benefit and if you are already living within your take home budget, you won’t miss the money.

The burden need not be placed solely on the shoulders of the employee, however. Plan sponsors can take actions that will help nudge their employees towards a more comfortable retirement. Gomez says, “The two best ways to implement a higher savings rate would be to amend the plan to add for an auto increase in the plan and the second is for retirement plan advisers to prepare an education meeting demonstrating how an increased savings rate can have little no impact on an employee’s take home pay. This meeting should also have contribution change forms to facilitate making the change right then and there.”

Again, the change in tax rates, at least as long as they remain, may make after-tax savings more attractive than tax-deferred savings. “Considering tax brackets are lower now and perhaps on a temporary basis,” Vogan, “a Roth IRA may be a much better bet for retirement savings.”

For 401k participants, this can get a little tricky. “Unless the employer is matching the contributions, it may not be the best idea for the average worker to put more money into a 401k, unless it is a Roth 401k,” says Mavilian. “Instead, given that their tax rates will be lower in 2018, they may want to pay the taxes in 2018 and invest in more tax efficient accounts, especially since the tax rates on individuals are set to expire in 8 years.”

Although the additional net pay generated by the tax cut may seem small ($2,000 a year comes out to about $38 a week), that saving that small amount generates big numbers over time. Jenkin says, “It really depends on your age, but for most people saving an extra $2,000 over 30 years at 8% will add an extra $225,000 in retirement.”

Saving a little earlier has an even bigger impact, even if the return is less. “Based on the rule of 72, and assuming an annual rate of return of 7.2%, your money will double every 10 years,” says Mavilian. “So, over a 40-year period, the $2,000 you save today, would be worth $32,000 in 40 years. Assuming the average worker saves 2,000 a year and contributes an additional $2,000 a year, at the end of a 40-year period, it would be worth $452,000.”

Still, you might not want to bank on all those future dollars yet. “The tax breaks are temporary so adjusting it based on those alone would only give an individual 8 years to add more to his current plan,” says Vogan. “The exact results and how it will affect one’s future is all but impossible to define since it will depend on too many factors, including age, income level and rate of return, for an individual. Any extra savings now will enhance your ability to spend more in the future, and tax savings can add to the extra amount you can save over the next few years. We just need to get over the immediate gratification we tend to favor and be wise planners by taking advantage of the new tax law while we can and saving rather than spending the extra.”

“The true effect of the tax bill still remains to be seen,” says Eric Bronnenkant of Betterment for Business in New York City. “For those who are seeing a reduction in their taxes, the additional money could mean more chances to increase 401k or IRA contribution, and in some cases, even max out one’s 401k. The best thing anyone can do – regardless of whether their taxes affect their decision to save – is take advantage of the nudges built into the system to encourage good habits. Set up automatic deferrals into your 401k or IRA, and schedule regular increases in that deferral amount.”

In the end, it falls upon the decisions retirement savers ultimately make. “It really gets down to the individual and their personal choices,” says Ilene Davis, of Financial Independence Services in Cocoa, Florida. “Most people haven’t been saving the maximum allowed by current law. The problem is not lack of options, but lack of responsibility. Anyone with a sense of personal responsibility can make a decision to save a portion of their income, regardless of new tax laws. Sadly, odds are strong the majority will just find more to spend.”

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary SolutionsHey! What’s My Number? How to Improve the Odds You Will Retire in Comfort and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on Twitter, Facebook, and LinkedIn.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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