By Kelly Campbell
The 2020 election is turning out to be one of the most controversial in decades. Very seldom in our history have we had such political polarity. One side favors high taxes, more government intervention and more help for the lower to middle class. The other side favors small business, less regulation and lower tax rates for all, including the wealthy.
However, while the big political themes will have an impact after the election, it is the details that will really matter. For the wealthy, especially those close to retirement, it is time to understand what each side wants to do to your retirement.
First, let’s talk about Social Security. For decades, the Social Security system has brought in more money than it has distributed. That is until now. Currently, the Social Security system is spending more than it is making because more people are retiring and collecting benefits than those that are contributing.
But that’s OK. With a few changes, the system could be fixed. For example, the federal government could raise the full retirement age (FRA) of Social Security recipients (like it did in 1983 when it phased the FRA from age 65 to 67 over a twenty-two-year period). They could also get rid of the cost-of-living adjustment (COLA), which means recipients would no longer get an increase once they begin receiving benefits. Another alternative is for the government to tax earnings more heavily.
The problem with any of these solutions is that any change in the Social Security system will lead to someone losing something — which also means political suicide. Even worse, the Congressional Budget Office (CBO) recently announced the reserves for the Old-Age and Survivors Insurance (OASI) Trust Fund could be exhausted by 2031, which is a year sooner than the agency predicted in 2019. Additionally, Social Security disability benefits could run dry by 2026 rather than the end of 2030, as noted in last year’s CBO Report.
What changes has each political party proposed? Not much to really solve the problem. It seems neither party wants to touch that ticking time bomb. Again, fixing Social Security is political suicide.
The Trump campaign has not addressed any changes to assist the crumbling system, but simply assures that they will not lower benefits. The Biden side actually wants to increase benefits for some individuals (those with income near the poverty level, widows, widowers, and some older retirees).
Under the Biden proposal, those ages 78 to 82 would gradually receive an increase on their payments over time. Also, a retiree with over thirty years of employment can receive 125% above the poverty line, helping the lowest of low-income earners. In addition, the benefits widow and widowers receive would increase by 20%.
To pay for this, they support the Bernie Sanders “donut hole tax,” where everyone with incomes between $0-137,700 would pay regular payroll taxes of 7.65% by the employer and 7.65% by the employee. As a result, there would be no OASI tax (6.2% for both employer and employee) for anyone, but the 6.2% tax begins again for any income over $400,000.
Under Biden’s plan, wealthy Americans may have to pay more into the system.
What about retirement plans like IRAs and 401(k)s?
Trump has not done anything to change current retirement benefits. On the other hand, Biden wants to equalize the tax benefits for those contributing to their retirement plans, while incentivizing lower income earners to contribute more to their savings.
Let me explain. Currently, any contribution to your company’s 401(k) plan is subtracted from your income before your income tax is determined. The higher your tax bracket, the more benefit you get for contributing the same amount of money. For example, if you make $200,000 per year and you contribute the current maximum contribution ($19,500 for those under the age of 50), your income tax will be based on $180,500.
Also, depending on which bracket you are in, you could get vastly different tax breaks for the same contribution. For example, someone in the 37% bracket will get a tax savings of $7,215. For someone in the 10% bracket, that same $19,500 contribution will receive a $1,950 benefit.
Biden has discussed replacing the pretax contribution with a flat tax credit option and proposed a tax credit for retirement plan contributions. Anyone who contributes the maximum amount will get a $4,000 tax credit. If you owe less than $4,000 in taxes, you still get the full (refundable) credit, meaning you could get a tax refund for contributing to your retirement plan.
This means a lower tax for lower- and middle-income earners. It also means that higher earners could likely subsidize the taxes and retirement benefits for lower income earners by paying more taxes. But that also leads to two interesting potential outcomes. First, if higher income earners get a lower tax benefit for contributing to their 401(k), they may change their position by contributing their savings to a Roth 401(k). In a Roth, they pay tax on the current contribution. The money grows tax free and then when withdrawn, the funds remain tax free. Second, if these higher income earners put their money into a Roth 401(k), tax revenues could immediately go up. While this may sound good in the short term, over the long term it means lower tax revenues. In the future, these same wealthy Americans will be able to withdraw from their retirement accounts tax free.
If this all seems like a shell game, it kind of is. There is more political jockeying than any real planning. If the true goal is to encourage lower- and middle-income earners to increase their retirement savings, there are other tax friendly ways to achieve this goal. For example, Congress could propose an increase in the saver’s credit, which is a credit for lower income earners for putting money into their retirement accounts.
The Biden proposal also includes Medicare benefits for Americans at age 60 — five years earlier than the current age 65. This plan significantly increases the financial obligation of the federal government as the Medicare system is already experiencing substantial funding issues.
Did Donald Trump forget about retirement altogether? Not necessarily. In late 2019, the SECURE Act was signed into law and had some fairly significant retirement benefits, including:
● Raising the required minimum distribution (RMD) age from 70 ½ to 72
● Implementing a tax credit for businesses that utilize the auto-enroll feature within their company retirement plan
● Easing regulations allowing small businesses to come together in order to offer retirement plans at reduced costs
● Eliminating age restrictions on IRA contributions
● Changing the RMD rule for “non-spouse” beneficiaries to no distribution requirements for ten years and then the full RMD at the end of that ten-year period
One additional change the Trump administration put into place in 2020 in response to COVID-19 was to suspend RMDs for this year. This allowed people to keep money in their retirement plans even after age 70 ½, which in turn kept them from having a bigger tax bill.
It does not appear that any of these ideas completely fix any of the major retirement issues. Many Americans’ retirement plans have gone into a downward spiral especially with the introduction of the pandemic. Further, each party is having a lot of discussions about policies to change the current trajectory.
The real question leading up to November 3 is: Can we expect real change or are they simply trying to win the election?
About the author: Kelly Campbell
Kelly Campbell, Chairman and CEO of Campbell Wealth Management in Alexandria, VA, has been in business for over 25 years and focuses specifically on retirement planning, estate planning, investment management and life planning for clients over the age of 55. From 2012-2017, Kelly Campbell has been recognized in the Top 25 in Virginia and in America’s Top 1200 Financial Advisors as named by Barron’s Magazine.