Breaking down retirement provisions in the tax reform bill
The retirement industry “dodged a lot of bullets” in terms of what could have been included in the GOP tax reform bill that would have negatively impacted retirement savings, according to Nevin Adams, chief content officer for the American Retirement Association.
But just because Rothification of workplace retirement plans didn’t happen and the reform bill didn’t include changes to non-qualified deferred compensation doesn’t mean that those topics won’t resurface in the future when it comes time to pay for other things Congress wants, he explains.
“I think Rothification is a concept that is out on the table now. If nothing else, people in both parties know that if you need to come up with extra money to pay for tax reform or want to redeploy that for infrastructure. There’s a big target on our back and we know it when the government comes looking for discretionary income,” Adams says. “The reality is the success of the private retirement system in this country has built up quite a bit of money Uncle Sam is not able to put his hands on. They will look for ways to change that dynamic so we need to remain vigilant.”
Here is what employers need to know about reconciled tax bill and how it affects retirement.
Cap on defined contribution plan deferrals/Rothification
When tax reform was first being discussed, the retirement savings industry was afraid that the House and Senate would pay for various tax cuts by putting a cap on how much employees could save in their workplace retirement plans on a pre-tax basis. The initial discussion centered around a cap of $2,400 pre-tax, a major reduction from the current cap of $18,000. Any additional contributions would have to be made into an after-tax Roth 401(k). Those provisions were eliminated from the discussion before the final House bill was released in November and were never included in the final Senate version.
Non-qualified deferred compensation
The initial House bill also included a provision that would have immediately taxed compensation set aside in non-qualified deferred compensation plans and discussed a proposal that any catchup contributions made after age 50 be funneled into a Roth plan instead of the employer’s traditional 401(k) plan. Neither the House or Senate bills included these provisions.
Deduction for pass-through entities
The final tax reform bill includes a provision that could impact whether or not small businesses host retirement plans.
The bill increases the deduction for qualified business income of pass-through entities to 20%. That means that pass-through businesses, like S corporations, would pay a lower tax rate by excluding as much as 20% of their business income from taxation. Retirement plan contributions are generally deducted against the S corporation’s business income, which under this provision, would be much lower than the income tax rate S corporation owners pay on retirement savings when they retire.
“The issue was how the tax reform bill would deal with deductibility of contributions to a retirement plan, as an individual or as a business owner, and at some point how that plays into their decision to offer a retirement plan in the first place because the legislation didn’t deal with the situation,” Adams says. “The working assumption is that they would have to deduct their retirement contributions against their business income rate, not against their income at the individual rate. As a consequence, the attractiveness of the deduction is much smaller because the income rate would be so much less.”
He adds that the National Retirement Association’s concern is that this undermines incentives for small business owners to not only save for retirement themselves but to set up a plan for workers. Adams believes the only “solution is to give business owners the deduction against their personal income,” which is at a higher rate, so that they have the ability to offset and deduct that against the same income at the same rate that they were charged with when the money comes out in retirement.
Treatment of outstanding plan loans
The final bill also includes a provision that would allow those who leave their current employer with an outstanding loan from their workplace retirement plan to not be taxed on the loan amount if they contribute the loan balance to an IRA by the date their individual tax return is due. Currently, individuals only have 60 days to make that rollover before they are taxed on the loan amount.
“That’s not necessarily going to be an issue for plan sponsors, but will help with some leakage issues they are concerned about,” Adams says. “From the standpoint of the retirement system, it’s a good next step. For a lot of people, particularly lower income people who have quit and have a loan, the easy answer at termination is to take the money and run and then they don’t have the money in hand to make up that loan outstanding, to pay it off and restore the money.”
David Musto, president of Ascensus, an independent provider of retirement, health and college savings plans, says that “coming up with the funds to repay an offset plan loan within 60 days (as is now required) can be very challenging.”
Retirement plan hardship distributions
The House bill proposed relaxing hardship distribution rules for employer-sponsored retirement plans. Currently, participants in a 401(k) plan aren’t allowed to withdraw any earnings on their elective deferrals and can’t make any new contributions to the plan for six months after they have taken a hardship withdrawal. The bill would have allowed all participants to take out their own money and earnings on that money. They also could have continued to contribute to their plan even after taking a withdrawal, which would allow them to take advantage of any company match on their contributions. The provision was eliminated from the final tax reform bill.