Congressional Tax Reform Efforts May Impact Retirement Plan Sponsors
On Saturday, the Senate passed its version of the Tax Cuts and Jobs Act. The process of reconciling the House and Senate versions of the bill has already begun in earnest. Currently, the retirement-plan-related changes included in each version of the bill still differ in many respects, and it is unclear which (if any) changes will be included in the final bill. As a result, with only a few weeks left until the holiday recess, a clear picture of the potential impact of tax reform on retirement plan sponsors has yet to emerge.
Early Saturday morning, following an all-night voting session, the Senate passed its version of the Tax Cuts and Jobs Act (Act), bringing Congressional Republicans one step closer to securing the most sweeping overhaul of the tax code in decades. Changes to the nearly 500-page bill, including handwritten revisions to the document, were still being made only hours before the final vote concluded just before 2 am on Saturday. Now that both the House and Senate have approved their own versions of the Act, they will begin the process of reconciling those versions to create a final bill, which must then be passed by both chambers.
Both the House and Senate versions of the Act include proposed changes that would affect all tax-qualified retirement plans, including both pension and savings plans. Despite early speculation, neither version of the Act includes the most controversial potential change, a proposal to significantly reduce the limit on pre-tax contributions to employer-sponsored 401(k) plans ($18,500 for 2018). In addition, the version of the Act passed by the Senate on Saturday does not include some of the more significant changes that would have applied to section 403(b) and governmental section 457(b) plans under the summary of the bill released by the Senate last month. However, both the House and Senate versions of the Act include a number of smaller changes that could impact retirement plan administration.
Of the retirement-plan-related changes currently under consideration, very few have been approved by both the House and Senate. Instead, many of the proposed changes appear in only one version of the Act.
Proposed Changes Approved by Both the House and the Senate
Rollovers of Loan Repayments
Both the Senate and House versions of the Act include relief that would extend the period for rolling over a loan offset. Retirement plan loans generally become immediately due and payable when a plan participant terminates employment. If the loan is not repaid, the plan offsets the loan against the value of the participant’s account. Currently, this type of loan offset may be rolled over by a participant tax-free if he or she makes an equivalent contribution to another tax-qualified plan or individual retirement account (IRA) within 60 days of the date of the offset. Both versions of the Act would extend this period, from the current 60 days to the due date (including extensions) for the affected participant’s tax return for the year in which the offset occurred.
Recharacterization of Contributions to Traditional and Roth IRAs
In addition, both the Senate and House versions of the Act would eliminate the ability to recharacterize a traditional IRA contribution as a Roth IRA contribution, as well as the ability to recharacterize a Roth IRA contribution as a traditional IRA contribution.
Proposed Changes Approved by Only the House
Expanded In-Service Distributions for Defined Benefit Plans
When the House version of the Act was passed last month, it included a rule that would lower the minimum age for receiving an in-service distribution from a defined benefit plan. Currently, defined benefit plan sponsors may allow active employees to request in-service distributions of their plan benefits beginning as early as age 62. The House version of the Act lowers the age for receiving this type of distribution to age 59½. The House version would also lower the age at which in-service distributions would be permitted from governmental section 457(b) plans from 70½ to 59½. Both changes would provide plan sponsors greater flexibility in plan administration; however, the Senate version of the Act does not currently include similar provisions.
Non-Discrimination Testing Relief for Closed Defined Benefit Plans
The House version of the Act also permanently extends the temporary nondiscrimination testing relief currently available to certain employers sponsoring closed defined benefit plans. Many employers have closed their defined benefit plans to new participants, but permit existing participants (or groups of participants) to continue to earn benefits under the plan. Because new employees can no longer enter the plan, closed plans can become discriminatory if the attrition rate of non-highly compensated employees outpaces the attrition rate of highly compensated employees.
Therefore, the House version of the Act provides permanent nondiscrimination testing relief that mirrors relief previously established by Notice 2014-5 and extended earlier this year. Like the existing relief, the permanent relief provided under the House version of the Act would make it easier for closed pension plans to satisfy certain nondiscrimination testing requirements by expanding the availability of cross-testing between defined benefit and defined contribution plans. However, the Senate version of the Act does not include this relief, meaning its inclusion in any final bill will need to be addressed in the reconciliation process.
The House version of the Act includes several provisions that would relax certain rules that apply to participants requesting hardship withdrawals from employer-sponsored 401(k) plans.
Specifically, the House version of the Act would eliminate the requirement that employers suspend employee contributions under 401(k) plans for the six month period following a hardship withdrawal. The House version of the Act would also eliminate the requirement that participants take all available retirement plan loans before receiving a hardship distribution and would expand the sources of 401(k) accounts currently available for hardship withdrawals (to include not only elective deferrals, but qualified non-elective contributions (QNECs), qualified matching contributions (QMACs) and earnings on those amounts), together with earnings on elective deferrals. The Senate version of the Act does not include any similar provisions designed to facilitate or expand the availability of hardship distributions. However, the summary comparison of the House and Senate versions of the Act, published on December 7, 2017, by the Joint Committee on Taxation, suggests that both versions of the Act include the same proposed changes to current hardship withdrawal rules.
Proposed Changes Approved by Only the Senate
Contribution Limits under Section 403(b) and Section 457(b) Plans
When the Chairman’s Mark of the “Tax Cuts and Jobs Act” (Chairman’s Mark) was released last month, it included a number of provisions that, if adopted, would have had significant implications for governmental section 457(b) plan sponsors who also maintain a 403(b) plan. However, the version of the Act passed by the Senate on Saturday does not include some of those more significant changes.
The Chairman’s Mark suggested that the Senate would adopt rules that would harmonize the contribution limits that apply to 401(k), 403(b) and 457(b) plans beginning next year, meaning that all 401(k), 403(b) and 457(b) plans (rather than just 401(k) and 403(b) plans) would have a combined deferral limit ($18,500 for 2018). The Chairman’s Mark also indicated that the Senate would (i) set a single aggregate limit on contributions to all 401(k), 403(b) and 457(b) plans maintained by the same employer; (ii) modify the special catch-up contributions available to certain 403(b) plan participants and the special contribution limitations for governmental section 457(b) plans; and (iii) eliminate a special rule under which employers may continue to make contributions to 403(b) plans for up to five years after an employee terminates from employment.
However, the Senate version of the Act passed on Saturday only includes one of the changes original proposed in the Chairman’s Mark, a rule that would increase the special contribution limitations for governmental 457(b) plans from $3,000 to $6,000 (as adjusted each year), to mirror the 401(k) plan catch-up contribution limit.
Given the substantial differences between the House and the Senate versions of the Act, it is unclear what changes, if any, retirement plan sponsors will be required to make to their plans. However, because these bills may affect retirement plan administration as early as 2018, employers should keep a close eye on the developing legislation. As the House and Senate continue the reconciliation process, a clearer picture of the potential impact of tax reform on retirement plan sponsors should begin to emerge over the next couple of weeks.