Tuesday, September 5, 2017
Daniel Hemel (Chicago), Is Rothification Just a Budget Math Gimmick?:
Trump administration officials and congressional Republican leaders are reportedly considering a proposal to “Rothify” retirement savings as part of a comprehensive tax reform package. The idea is that instead of excluding 401(k) contributions from taxable income in the year they’re made and then paying tax on withdrawals, individuals would pay tax on 401(k) contributions in the year they’re made and then be able to withdraw tax-free. The latter approach — already an option for individuals whose employers offer Roth 401(k) plans — would become mandatory with respect to some or all 401(k) savings. Similar changes on the IRA side would push individuals from traditional to Roth accounts.
As intro income tax students know, the difference between traditional and Roth plans shouldn’t matter for individuals whose marginal rates remain the same: both are equally attractive in present value terms. And the conventional wisdom holds that the difference shouldn’t matter for the Treasury either (assuming again constant rates). The choice between traditional and Roth plans affects the timing of tax collections but not the present value of tax collections. For this reason, the Republicans’ Rothification proposal has been characterized as a gimmick to make their tax package appear as though it loses less revenue than it does. ...
[T]he conventional wisdom regarding Rothification overlooks an important institutional wrinkle: management fees. Firms that manage 401(k) plan assets charge fees as a percentage of assets under management (AUM). That means that firms like BlackRock, Fidelity, and Vanguard should strictly prefer the traditional approach rather than Rothification because the traditional approach leads to more assets under management, and thus more fees. ...
In sum, Rothification might be more — much more — than a budget math gimmick. And for precisely that reason, the prospects of passing Rothification look rather slim.