As administrations change, policies change that can have a large impact on you and your financial future. We stay on top of all of these changes so that you know what to look out for and how to prepare, and are never caught unawares.

Recently, the Biden administration has put forth plans to change 401(k)s. Before we discuss these changes and how they may affect you, it is important to understand the differences between tax credits and tax deductions, as these two factors play a critical role in these changes.

 

 

Tax Credits vs Tax Deductions

To state it simply: tax credits reduct the amount you will pay in taxes. Dollar for dollar, the amount you owe on your taxes at the end of each year will decrease based on your tax credits.

Conversely, tax deductions reduce the level of income that will be taxed. By lowering the amount of money that is subject to being taxed, the amount of taxes that you owe will decrease.

Why does this matter for 401(k)s? By moving money into your 401(k), you receive a tax deduction. This is an important thing to understand, because this is the fact that is being changed by this administration.

401(k) Updates

The Biden administration 401(k) plans are to create a simple, flat tax credit across the board of a proposed 26%. That means that if you contribute to a 401(k), you will receive a 26% tax credit. This has been seen as an issue by those in higher earning tax brackets because by deferring their income, they were saving some on their taxed. For lower earners, however, this is being viewed as a benefit- they can save more and then have more relief on their taxes.

The repercussions of this are twofold: higher earners may decide to not add as much to their 401(k)s because they are no longer seeing the benefit of it from a tax basis, while lower earners will add more in order to receive more tax relief.

Keep in mind that there is a cap on how much can be added to your 401(k), and that’s based on your age. Those under the age of 50 cannot add as much as those over the age of 50. While there is a maximum of what you can contribute, no matter what you do contribute, under this proposed change you will still receive that same 26% tax credit.

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Here’s an important thing to remember as you decided on what to add to your 401(k) plan: taxes are likely to increase at some point. A tax credit now may not be worth the taxes you will pay on this later, when it comes time to use it. For this reason, looking into a Roth 401(k) or Roth IRA may be the better choice, as it allows you to generate tax-free income for later.

Here’s an important thing to remember …

Here’s an important thing to remember as you decided on what to add to your 401(k) plan: taxes are likely to increase at some point. A tax credit now may not be worth the taxes you will pay on this later, when it comes time to use it. For this reason, looking into a Roth 401(k) or Roth IRA may be the better choice, as it allows you to generate tax-free income for later.

When you’re wondering how to retire with confidence, come to B.A. Schrock Financial Group, where our expertise can save you a lifetime of stress and create a confident financial future. Contact us today to find out more about our offerings and services or learn more useful financial tips on our weekly podcast.