The Fiscal Cliff And Your 401(k)
With the end of the year rapidly approaching, President Obama and members of Congress are working frantically in an effort to avoid going off what the media has termed the fiscal cliff, when a number of major tax cuts that were instituted by the Bush Administration will expire and several major governmental spending cuts will simultaneously go into effect. Many economists fear that this combination could push the fragile U.S. economy back into a deep recession, and politicians are therefore laying virtually everything out in the tax code in an effort to avert this possibility. However, many taxpayers are unaware that "everything" includes one of their most precious assets: their retirement savings.
Untouchable No Longer?
For decades, the monies that have been contributed to 401(k) and other employer-sponsored qualified plans have been regulated by the government but not taxed until withdrawal. Nevertheless, the current tax rules that permit contributions of up to $17,000 per participant in 2012 may change drastically as lawmakers seek a source of revenue that can keep America from falling off the ledge. Congress may decide to curtail the amount of money that can be contributed to these plans, perhaps by lowering these limits to the same level as for IRAs. Congress could also eliminate some or all of the tax deductions that participants now get for their contributions into traditional plans. They could, in fact, even revoke the tax-deferred status of all of these accounts, and this possibility is sending cold chills through the pension community. The American Society of Pension Professionals and Actuaries is actively working to alert the public on this matter, along with various other media outlets and financial groups. America has nearly $10 trillion packed away in these accounts. Over 60 million Americans contribute to 401(k) plans alone, and the majority of them have incomes of less than $100,000 per year. Many retirement experts are afraid that the removal of these tax advantages will also remove the incentive for Americans to save for retirement, since there may not be any immediate reward for doing so or at least not enough of one.
The Recession Factor
Even if Congress does not reduce the tax incentives on our retirement savings accounts, the other side of the coin for Americans may not be much better. If America goes off the fiscal cliff and heads back into another recession, then Americans could see a decline in their account balances that might equal the loss of their tax incentives in terms of actual dollars. Of course, this may still not be as bad as losing the tax advantages in our retirement accounts, because the recession is bound to end at some point, but the loss of tax advantaged-retirement savings plans might be permanent. Investors may seek individual stocks as a new haven for their money, since capital gains in stocks aren't currently taxed until they are sold. However, this might change if Congress feels that taxing unrealized gains is necessary to keep the nation financially on track.
The Bottom Line
Until Congress reaches some kind of resolution about how to deal with the fiscal cliff, taxpayers are going to have to stay tuned and be prepared to make last-minute changes in their finances in order to accommodate the new rules that are made. For more information on the fiscal cliff, visit the IRS website or consult your tax or financial advisor.