Employer Matching 401(k) = Savings Account for the IRS

From the Dallas Morning News:

"Today's Rude Opinion Poll: Which description best characterizes our elected representatives in Washington, regardless of party affiliation?

"• They are hapless boobs, constantly passing laws that contradict each other.

"• They are scheming miscreants, relentlessly seeking new ways to increase taxes and spend more of our money.

"If you think the choices are unkind, please bear with me while we study a little legislative history.

"You'll see how our lawmakers have decided to take the money your employer contributes to your 401(k) plan today and transfer most or even all of it to the federal government during your retirement years.

...

"In 1983, a presidential commission recommended that Social Security benefits be taxed. The recommendation became law in 1984.

"At the time, few retirees were affected, because benefits were only to be taxed when other sources of income were quite high.

"With the initial level set at $25,000 for a single return and $32,000 for a joint return, it was expected that only 1 percent of beneficiaries would pay any taxes on their benefits.

"But there was a catch. The income levels weren't indexed to inflation.

...

"The average Social Security check is $1,048 a month, or $12,576 a year. So an average two-earner couple may have benefits of $25,152.

"Subtract half of this amount from $32,000, and you have the amount of income they can have from other sources before benefits become taxable – $19,424.

"Once their other income exceeds $19,424, every additional dollar causes either 50 cents or 85 cents of Social Security benefits to be added to their taxable income.

...

"Now let's consider the composition, and disposition, of each dollar that goes into a typical 401(k) plan.

"In a typical plan, every dollar of employee contribution is matched by 50 cents of employer contribution. So each dollar going in is 67 cents of employee money and 33 cents of employer money.

"Question: What is the composition of each dollar coming out?

"Answer: There are four levels, depending on your tax status. Here they are.

"Level 1: At this level, no Social Security benefits are taxed. Assuming a 15 percent tax rate on the 401(k) income, 85 cents of each 401(k) dollar will go to the employee and 15 cents to the IRS. That's a reasonable deal that's rapidly disappearing.

"Level 2: At this level, 50 cents of Social Security benefits are taxed for each dollar withdrawn from the 401(k). In effect, 77.5 cents of each dollar from the 401(k) will go to the employee and 22.5 cents will go to the IRS. About two-thirds of the employer contribution goes straight to the IRS.

"Level 3: Here, 85 cents of Social Security benefits are taxed for each 401(k) dollar withdrawn, and the basic tax rate is 15 percent. So 72.25 cents of each 401(k) dollar goes to the employee and 27.75 cents of each dollar goes to the IRS. About 84 percent of the employer contribution goes to the IRS.

"Level 4: As in Level 3, 85 cents of Social Security benefits are taxed for each 401(k) dollar withdrawn, but the basic tax rate is 25 percent. As a consequence, 53.75 cents of each dollar goes to the employee and 46.25 cents goes to the IRS. In effect, the entire employer contribution (33 cents) plus 13.25 cents of the employee contribution goes to the IRS.

"How this tax mess will affect you depends on your income level and your age. If you are young, odds are your employer contribution will never buy you a slice of bread. It's really a fund for the IRS.

"So I'll ask the question again: Are politicians hapless boobs or evil schemers?"

HT: Division of Labour post