Retirement Savings Left Largely Untouched by Tax Reform

January 3, 2018

While rumors flew around Washington in the fall that the Tax Cuts and Jobs Act would dramatically impact retirement accounts, the plan has made only a few minor modifications. Under the current system, retirement plans are rightly subject to only a single layer of taxation, but they are governed by numerous confusing rules and restrictions. Though some of the new changes ease restrictions, the need to reform the disorganized structure of retirement savings remains.

Plan Loans and Offsets

Some plans may offer participants the option to take out a loan, subject to several Internal Revenue Service (IRS) restrictions. Generally, the loan must be paid back within five years with quarterly payments. Loans that are not paid back are deemed distributions and are treated as early withdrawals subject to income tax and possibly additional early withdrawal tax. If an employee is terminated and has an outstanding loan, the outstanding loan amount is “offset” from the retirement account balance. To avoid the offset amount being treated as a distribution, an individual may come up with funds elsewhere to replace the offset amount when rolling over the old account into a new account.

Change

Extends rollover period for offset loans from 60 days to the due date for filing taxes in the year of an offset loan distribution, having a negligible revenue impact.

IRA Recharacterizations

Current IRS rules allow individuals who have money in traditional IRAs to convert all or part of that money to a Roth IRA. These conversions enjoy the same benefits as regular Roth IRAs, and avoid Roth IRA’s contribution limits. In exchange, individuals pay incomes taxes on the amount they convert. If an individual later wished to undo (or reverse) a conversion to move back to a traditional IRA, the tax code allows a recharacterization, subject to certain requirements and deadlines. Recharacterizations are quite complicated, but they may be advantageous in some situations. For example, individuals may choose to recharacterize if the tax burden on a Roth conversion was more than they expected, if they are in a higher tax bracket due to unexpected income, or if they don’t have enough cash to pay the taxes incurred by a conversion.

Change

Repeals the rule allowing the recharacterization of converted Roth IRAs to traditional IRAs. This change is estimated to increase federal revenues by $0.5 billion over ten years.

Disaster Areas

One of the changes made to casualty, disaster, and theft losses is the inclusion of a special rule that will impact retirement accounts. The rule applies to individuals living in 2016 presidentially declared disaster areas and allows up to $100,000 in distributions taken from retirement plans and IRAs to be exempt from the 10 percent early withdrawal tax, included in income over a three-year spread, and eligible for repayment within three years. The estimated revenue effect for this change and other changes associated with 2016 presidentially declared disaster areas is a loss of $4.6 billion in federal revenues over ten years.

The changes included as part of the Tax Cuts and Jobs Act will likely affect relatively few taxpayers and will largely maintain the current structure and regulations faced by retirement savers today. Though easing restrictions and extending time frames generally make the tax code easier to navigate, these provisions are some of the lesser-utilized functions of retirement savings. Thus, the impact will be minimal and the swath of complex regulations applying to long-term savings will remain largely intact and in need of reform.

For more about the restrictions on long-term savings, see here.

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