Senate bill may make retirement plans less attractive for some employers

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Though the new Senate tax reform bill, passed Saturday morning, leaves retirement plans, including 401(k)s, unscathed, one provision may have an impact on whether or not some small businesses offer retirement plans.

The decision by the Senate to increase the deduction for qualified business income of pass-through entities from 17.4% to 23% may produce an unintended consequence: that “the tax incentives S Corporation owners [receive] to sponsor a retirement plan become much less attractive in a lower-tax-rate environment,” Doug Fisher, director of retirement policy at the American Retirement Association, explains in analysis on

This happens under the S Corporation tax rules because retirement plan contributions are generally deducted against the S Corporation’s business income, which under the Senate bill would be much lower than the income tax rate S Corporation owners pay on retirement savings when they retire.

“S Corporation shareholders may be better off financially if they forego a retirement plan contribution and instead pay tax on their savings and invest the proceeds outside the plan,” Fisher writes. “The attractiveness of a retirement plan is further diminished when a business owner factors in the cost of contributions to meet plan testing rules, plan administration costs and the ERISA fiduciary risks associated with operating and administering a qualified plan.”

However, it is mostly good news for employers when it comes to how the bill affects retirement plans.

Currently, “retirement provisions in the bill are not intended to raise money. Most see them as policy improvements,” says Geoff Manville, principal and leader of the government relations team at Mercer’s Washington Resource Group. The Senate bill would ease non-discrimination testing rules for closed pension plans, which is “aimed at enhancing retirement security and plan participation rather than raising money,” he says. “Some of those won’t have much, if any, revenue effect, so they may be dropped because these won’t impact the federal budget.”

Both the House and Senate bills eliminated changes to non-qualified deferred compensation and any references to forced Rothification or cuts to tax incentives for retirement plans.

“One of the reasons Republicans avoided Rothification, beyond Trump’s tweet to Congress to not even think about it, is it would affect a lot of people, especially the middle class,” Manville says.

The initial idea that was discussed, but never made it into either bill, would have cut the tax-deferred contribution limit on 401(k) plans from $18,000 a year to $2,400 annually. Any deferrals over that cap would be given the Roth after-tax treatment.

“The pre-tax deferral element is a big selling point for defined contribution plans, and there’s been a huge worry that trading away that tax incentive today will result in less take-home pay if you don’t change your deferral rate. It might increase cash-outs if you need to put after tax money in there and discourage people from offering plans. We are happy that is out,” he adds.

Manville points out that “we’re not entirely out of the woods yet. It could theoretically be revived on the floor or during House/Senate talks if they need more revenue. We are guardedly optimistic.”

The Senate bill that came out of the Senate Finance Committee has a provision that would harmonize the contribution limits that apply to 401(k), 403(b) and 457(b) plans effective in 2018, meaning that they all would have a contribution limit of $18,500 in 2018, plus a $6,000 catch-up contribution for people 50 or older.

The Senate bill effectively repeals special catch-up contributions under 403(b) plans and special contribution limitations for governmental 457(b) plans, says Paul Strella, senior partner for Mercer.

“This is not an enhancement to the retirement system, but it does simplify a very confusing set of rules,” he adds.

Dan Notto, ERISA strategist retirement solutions for J.P.Morgan Asset Management, said in a special bulletin that the Senate bill would eliminate a person’s ability to make contributions to a traditional or Roth IRA for a year and then “re-characterize that contribution as a contribution to the other type of IRA by transferring it to the other type of IRA by his or her tax return due date.”

Another provision included in the Senate version of the bill is that individuals who leave their current companies with an outstanding loan from their retirement plan would 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.

Annette Guarisco Fildes, president and CEO of The ERISA Industry Committee, sent a letter to Sen. Orrin Hatch on Nov. 30 saying that her organization “applauds your efforts to develop tax reform legislation without adversely impacting the ability of workers and families to save for retirement. We look forward to working with you to advance retirement savings measures in future legislation.”

ERIC is a national association that advocates for large employers on health, retirement and compensation public policies at the federal, state and local levels.

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