We're getting close to the presidential election, and both candidates have made all sorts of proposals on ways to change things from taxes to healthcare to the COVID-19 pandemic. Democratic candidate Joe Biden has proposed a change to the tax benefits for making 401(k) contributions, so here's a rundown of what the change would be and how it might affect real estate investors.
Biden's 401(k) proposal in a nutshell
My colleague at our sister website The Motley Fool, Catherine Brock, recently wrote an excellent and detailed discussion of Biden's 401(k) proposal. So, if you really want to dig into the numbers and see how it could affect your tax bill, be sure to check it out. But here's the quick version:
Under current tax law, 401(k) investing favors high-income households. Think about it this way -- if you're in the 12% tax bracket and set aside $5,000 in your 401(k) in 2020, you'll save $600 on your taxes this year. On the other hand, if you're in the 37% tax bracket and set aside $5,000, your tax break is worth $1,850. In other words, the higher-income individual gets more than three times the tax break for setting aside the exact same amount of money.
Biden's plan aims to level the playing field. Instead of structuring the 401(k) contribution benefit as a deduction, the value of which is based on marginal tax rate, Biden proposes making it a credit, which would have the same value for everyone.
For example, if Biden proposed a tax credit worth 25% of 401(k) contributions, both individuals in our previous example would get $1,250 in tax savings. The idea is to make saving for retirement equally valuable for all Americans, regardless of their income level.
How could it affect real estate investors?
The short answer is that in most cases, it wouldn't. Employer-sponsored 401(k) plans don't allow participants to make real estate investments (except in mutual fund form).
However, it is possible to use an old 401(k) from a former employer, or a solo 401(k) if you're self-employed, to invest in real estate. This is known as a self-directed 401(k) and allows for money to be put to work in assets other than traditional options like stocks and bonds.
Because of the high cost of real estate investments, most people who use this route roll over their old 401(k) balances. But self-employed individuals can continue to contribute to their accounts as long as they have self-employment income, so the proposed tax change could potentially make the tax benefits of investing in real estate this way less valuable.
It's just a proposal
As a final thought, it's important to keep in mind that this is just an idea at this point, and there's no way of knowing when (or even if) it could become a reality. Politicians propose changes during campaigns more for the purpose of letting voters know where they stand, and it doesn't necessarily mean they'll be pushing for those exact changes.
For example, think back to President Trump's campaign tax platform -- some of what he proposed happened, some didn't. The standard deduction did end up doubling, and the tax code definitely became a bit more simplified in terms of deductions. However, one of Trump's proposed changes was to change the number of tax brackets from seven to three and to make it so most Americans could file taxes on a postcard. Did that happen? Not exactly.
The bottom line is that this proposed change would only affect a small subset of real estate investors -- those who invest in real estate through a self-directed 401(k), earn a high income, and actively contribute to their account. And even if that describes you, this is just an idea at this point. So take it with a big grain of salt.