Tax Reform Results in Only Minor Changes for Retirement Plans
The Tax Cuts and Jobs Act made significant changes to the tax code and will have a significant impact on businesses and individual taxpayers. However, although initial proposals included potentially significant changes to employer-sponsored retirement plans, the impact of the final bill on employer sponsored retirement plans will be relatively minor.
The Tax Cuts and Jobs Act (the Act), which was signed into law on December 22, 2017, represents the most sweeping overhaul of the tax code in decades and will have a significant impact on businesses and individual taxpayers. However, there are no major changes to the structure, type or amount of benefits that may be provided by employers through their tax-qualified retirement plans under the new law. Early proposals suggested that Congress might attempt to significantly reduce the limit on employee pre-tax deferrals to employer-sponsored plans, but the Act does not reduce contribution, benefit or compensation limits in 401(k) plans, does not cap wages on pre-tax catch-up contributions, and does not change the rules for pre-tax contributions to 403(b) and 457(b) plans.
In addition, the Act does not expand the in-service withdrawal rules available to defined benefit and money purchase plan participants, and does not make permanent the nondiscrimination testing relief for closed defined benefit plans previously established by Notice 2014-5 and extended earlier this year, which were proposals approved by the House in an early version of the Act. Similarly, the Act does not make changes to hardship withdrawal rules, such as the elimination of the requirement that employers suspend employee contributions under 401(k) plans for the six month period following a hardship withdrawal.
However, the Act does include a handful of smaller changes that will impact retirement plan administration, described more fully below.
Rollovers of Loan Repayments
The Act includes relief that extends the period for rolling over a loan offset. Retirement plan loans typically become immediately due and payable when a 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. Beginning in 2018, the Act extends 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 as Roth or Pre-Tax
Currently, individuals have the ability to convert funds contributed to a traditional pre-tax or Roth IRA to the other type of IRA. Individuals who convert pre-tax contributions as Roth contributions are required to pay taxes on those amounts at the time of conversion. Under existing law, taxpayers normally have until October 15 of the year following the conversion to change their mind and undo the conversion transaction. This means that a taxpayer can decide he or she does not want to be stuck with the tax liability associated with all or part of the conversion transaction and can go back and change it.
Under the Act, an individual will no longer be allowed to reclassify (or “recharacterize”) a converted amount. This means, for example, that if an individual transfers money from a traditional IRA (or from a pre-tax contribution source in his or her employer retirement plan to a Roth IRA), the individual will not be allowed to reclassify the amount for tax years beginning after December 31, 2017. If a taxpayer completed a conversion at any time in 2017, it is unclear whether this means that the taxpayer must reverse that action by December 31, 2017, or will have until October 15, 2018, to do so.
Contribution Limits under Governmental Section 457(b) Plans
Governmental and other tax-exempt plan sponsors are subject to certain limits on the deferral of compensation. However, under current law, a special length of service award made to a volunteer who provides firefighting and prevention, emergency medical and ambulance service is not treated as deferred compensation as long as the aggregate amount the volunteer accrues for each year of service does not exceed $3,000. Beginning in 2018, the Act doubles this limit to $6,000 (as adjusted each year for cost-of-living).
2016 Disaster Area Relief
The Act also contains tax relief for certain retirement plan and IRA distributions taken on or after January 1, 2016, and before January 1, 2018, by an individual whose primary residence was located in a federally declared disaster relief area during 2016 and who sustained economic loss as a result of such a disaster. For distributions treated as a “qualified 2016 disaster distribution,” the Act: (1) provides an exception to the 10 percent early distribution penalty; (2) exempts the distribution from mandatory 20 percent withholding; (3) permits ratable income inclusion over three years; and (4) permit repayments or rollovers (to the extent that a plan or IRA accepts rollovers) within three years. This special tax treatment is limited to distributions not in excess of $100,000. While not entirely clear from the text of the Act, we believe such distributions are only available if permitted by the plan, subject to further guidance from the IRS.
The disaster relief is similar to the retirement-plan-related signed into law after Hurricanes Harvey, Irma and Maria.
Although the retirement plan changes in the Act are few, plan sponsors should be prepared to consider and implement the changes in 2018. In particular, changes to loan rollover procedures will require updates to plan administration, participant communications, and possible plan amendments.