For the first time since the 401(k) was born in 1978, both chambers of Congress may be in agreement on on thing: the severe reduction or outright elimination of the deduction contributors to a 401k enjoy. Here’s the skinny:

Back in 2017, when the Republicans controlled the House of Representatives, and under the direction of President Trump, they were discussing sweeping tax cuts as part of the largest tax cuts since President Reagan’s Tax Reform Act of 1986. This Tax Cuts and Jobs Act of 2017, which we wrote about when it was passed, made significant changes to the tax code designed to lower taxes.

But since taxes are the government’s sole source of revenue, when taxes go down, less money goes to the government (and under the 2017 changes, it was projected that revenue would fall by $1.5 Trillion over 10 years), which means they either need to cut costs or make up the shortfall elsewhere.

During the legislative discussions, House Republicans discussed limiting the qualified tax deduction to the first $2,400 contributed.

Here at the Fortune Law Firm, we are pretty outspoken about how qualified plans are not a good deal for Americans looking to build a retirement, but there are still 55 million Americans who have money in qualified plans who are counting on those deductions to lower their tax burden every year.

Regular contributors to 401ks and other qualified plans breathed a sigh of relief when the Trump Tax Plan was enacted without these changes to the qualified deduction.

Fast forward just over three years to the present, 2021. President Biden is in the White House, and Democrats hold the majority in both the Senate and the House of Representatives. President Biden has proposed eliminating the 401(k) tax deduction and giving a tax credit for those same contributions.

The way the deduction currently works, it provides the biggest incentive to higher earners because the value of the deduction is dependent on your tax bracket. The higher the tax bracket, the more the deduction is worth.

For example, an employee who earns $40,000 is in the 12% tax bracket. That means their $6,000 in contributions saves them $720 off their tax bill. The same $6,000 contribution to someone making $100,000 saves them $1,440 in taxes because they’re in the 24% tax bracket. Someone earning $250,000 per year saves $2,100 in taxes with the same contribution because they’re in the 35% tax bracket.

These three individuals will pay and save these amounts in taxes, respectively:

Taxable Income	Highest Tax Bracket	Total Tax Bill (before deduction)	Tax Savings on $6,000 Contribution
$40,000	12%	$3,095	$720
$100,000	24%	$15,009	$1,440
$250,000	35%	$57,651.75	$2,100

As a percentage of the total tax bill, the deductions for these three earners reduces their total tax bill by 23.3%, 9.6%, and 3.6%, respectively. Although the tax deduction already more heavily favors the low-income earners, Biden’s proposal would convert it to a tax credit so the amount of tax savings would be the same, irrespective of income.

The tax credit proposal is 26% of the contribution (or at least, that’s our reading of it—it’s not entirely clear), so it would mean the same tax savings for everyone, irrespective of tax brackets. So these same contributors under the new plan would see tax savings as follows:

Taxable Income	Highest Tax Bracket	Total Tax Bill (before tax credit)	Tax Savings on $6,000 Contribution
$40,000	12%	$3,095	$1,560
$100,000	24%	$15,009	$1,560
$250,000	35%	$57,651.75	$1,560

Under this plan, as a percentage of the total tax bill, the credit for these three earners reduces their total tax bill by 50.4%, 10.4%, and 2.7%, respectively.

Using this example, you can see that the deduction does indeed favor those in the lower income brackets at the expense of those in the higher brackets.

Because the difference between the 24% and the 32% tax bracket for a single filer is the difference between whether you earn more or less than $164,926, this tax change would negatively affect those earning more than this, and have a net positive effect on those earning less.

There has also been discussion, though much more oblique, about doing away with the deduction for the employer contribution to the employee’s qualified plan.

At this point, a lot is still up in the air, and none of these proposals has, as of the time of writing, solidified into an actual congressional bill.

What we do know is that governmental spending is at an all-time high (by several multiples), and taxes are at almost historical lows. No matter what happens, there seems to be little doubt that taxes will increase.

Is the 401k Deduction Going Away?