The goal of the proposed Biden 401k is to “push down” the tax benefits of 401k participation to 80% of American workers who earn less than $175,000 in W-2 wages. Currently, these workers are receiving only 35% of the tax benefits of all 401k participants, and workers earning more than $175,000 are getting 65% of 401k tax benefits. The objective of the Biden 401k is to equalize 401k tax benefits across all income groups.
Suppose your W-2 adjusted gross income (AGI) exceeds $175,000 per year. You are in the upper 20% of all wage-earners. Under the Biden 401k, you will see a reduction in the tax-deferral benefits of your 401k contributions compared to previous years. On the other hand, if you earn less than $175,000, you will see a gradual increase in tax-deferral benefits compared to last year.
The reason is that the 401k payroll contributions you make are made with pre-tax dollars. The pre-tax contributions create a year-end tax deduction that reduces your taxable income. This 401k tax benefit is currently skewed toward higher-income families because their income tax bracket is higher, so their year-end deduction is higher.
President Biden Is proposing a way to “equalize” these 401k tax benefits across all income groups. The idea is to give lower- and middle-income workers a tax credit of 26% of their annual 40k contribution. For example, suppose you are a middle-class wage earner and contribute $8,000 to your 401k. In that case, you will be entitled to a tax credit (not a tax deduction, but a credit!) of $8,000 X .26 = $ 2,080 credit. Any knowledgeable tax adviser will confirm that taxcredits are far more valuable to you than tax deductions, which is what you get now with a 401k.
As an aside, It is anticipated that a Biden 401k would result in more high-income wage earners gravitating to Roth 401k accounts. Roth 401k contributions are made with after-tax dollars, but like the traditional 401k, investments grow tax-deferred until used at retirement.