Biden’s tax plan and its potential impact on corporate retirement plans
With Democrats gaining control of the White House and both houses of Congress in January, it is likely that we will see changes to the tax code in the near future. Below we break down a few of the major changes in President Biden’s proposed tax plan, what these changes could mean for corporate retirement plans and what sponsors can do now to prepare.
What is the proposed tax plan?
President Biden has promised that families earning below $400,000 will not see an increase in their income taxes. For individuals and families earning over $400,000, the following changes are proposed:
- An increase in the top marginal income tax rate from 37% to 39.6%.
- A Social Security payroll tax of 12.4% on income over $400,000, split between the employer and employee. The 2021 Social Security payroll tax limit is $142,800.
- The value of itemized deductions would be reduced as incomes rise and would be capped at 28% (currently there is no cap).
For individuals with more than $1 million in income, both long term capital gains and qualified dividends would be taxed as ordinary income.
For corporations, President Biden proposes increasing the income tax rate from 21% to 28%.
For all individuals, regardless of income, the plan creates a tax credit for retirement savings (proposed at 26% for each $1 contributed), replacing the current tax deduction, thus lowering the tax savings for taxpayers with effective tax rates above 26%.
What could this mean for retirement planning?
If the Biden plan is enacted, high earners will face tax increases of nearly 9% for earnings over $400,000 as well as a reduction in the value of itemized deductions. Therefore, many higher earners will want ways to defer some portion of their income. We believe this will result in increased demand for Non-Qualified Deferred Compensation (NQDC) plans, which are offered by employers to attract and retain key talent. NQDC plans often look very similar to 401(k) plans to participants. But there are important differences for both employees and employers. There are also pros and cons to NQDC plans, such as:
- Bankruptcy risk
- Management changes resulting in a change to the plan
- Potential hedging/financial risks
For plan sponsors with existing NQDC plans, we believe now is a good time to review their plan’s structure in anticipation of greater demand to ensure the NQDC plan still meets the objectives of the sponsors and participants.
If corporate tax rates rise, we foresee profitable cash generative companies looking to increase funding to existing defined benefit plans. Increased contributions will increase the tax deduction for the company as well as potentially reduce costs, such as PBGC premiums.
Moving from a tax deduction to a credit to incentivize retirement savings may lead to changes in 401(k) participation. Tax credits will provide a larger incentive for lower income individuals to save for retirement, potentially increasing the number of participants and/or the amount these participants are saving into the plan. A tax credit is worth less to a higher income earner than a tax deduction, so there will be less incentive for higher income earners to save via a traditional 401(k). This might sway higher income earners to convert their contributions to after-tax, Roth contributions. Plan sponsors should ensure their 401(k) plan has a Roth option and should reevaluate all current service providers to ensure they can handle increases in participation. With the potential for more money and additional participants, it’s more important than ever to make sure the plan is in compliance with regulations, offers a strong and easily understood investment lineup, is delivered at an appropriate cost to participants, and is following best practices, including offering employee advice options.
While it’s uncertain what a final tax bill will contain, there are likely potential changes that could impact corporate retirement plans and plan sponsors.
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