Will income tax changes kill retirement plan tax advantage?

[Flyboyjohn]

For those that like to run projections of the net after-tax advantage of pre-tax retirement plan savings you might consider this possible scenario:

Maximum Federal rate on wage, pension & other regular income 33%

Maximum tax rate on business income from flow-thru entities not paid to owner(s) as wages 25%

Exclusion from tax of 50% of interest, dividends & capital gains (making max tax on investment income 16.5%)

So the self-employed doctor has the following choice:

1. Keep $50,000 of business income, pay tax at 25%, reinvest after tax at 16.5% tax rate on earnings

2. Put $50,000 into a PS plan (assume doctor is only participant), save current tax at 33% but ultimately pay tax on all distributions at 33%

Some commentators say the results shift to favor option 1 even when you disregard the possibility of having to make contributions for eligible employees and pay plan administrative costs.

Of course such a scenario would also need to consider making the $50,000 contribution as ROTH (immediate conversion of employer contributions to ROTH) which may result in ROTH becoming the game of choice for professional practices.

 

 

[CuseFan]

A reduction in tax rates could trigger a slew of Roth conversions, if still available, and yes, make Roth the "game of choice" as you say. The advantages of qualified plans compared to after tax savings are (1) the business owner actually does save and invest the funds for retirement (I just met with a doctor who is concerned with getting by on $500k - spending up to their income and not setting funds aside is a problem) and (2) the funds are protected from creditors. But any good accountant will tell you to tax diversify your (retirement) assets regardless. The ultimate losers will be employees if business owners determine they don't need qualified plans any more.

[RatherBeGolfing]

17 minutes ago, CuseFan said:

A reduction in tax rates could trigger a slew of Roth conversions, if still available, and yes, make Roth the "game of choice" as you say. The advantages of qualified plans compared to after tax savings are (1) the business owner actually does save and invest the funds for retirement (I just met with a doctor who is concerned with getting by on $500k - spending up to their income and not setting funds aside is a problem) and (2) the funds are protected from creditors. But any good accountant will tell you to tax diversify your (retirement) assets regardless. The ultimate losers will be employees if business owners determine they don't need qualified plans any more.

I agree with the above.  I just had this conversation with a fellow industry professional last week.  He didn't agree with #2 since the bankruptcy laws don't really track with QP law.  Specifically, his concern was that the IRS making it more difficult to obtain det letters will erode QP protection against creditors unless bankruptcy laws are amended to fall in line.  I'm not as concerned as he is (yet) but it is an argument to keep in mind.