What the House, Senate tax bills mean for retirement
As the House and Senate move this week to reconcile their two tax reform bills, many worry that conversations about pre-tax contribution limits and possible Rothification of plans could resurface, particularly since there are a group of Republican senators who “were resistant to any tax reform that would heighten the deficit,” says Shelby George, senior vice president of adviser services for Manning & Napier.
The deficit hawks in Congress lost this last round —the Senate passed its version of the bill in the wee hours Dec. 2 — so none of these provisions made it into the House or Senate bills.
“Retirement plans are safe for now but there is a question of whether they will continue to be safe as both sides of Congress reconcile to find terms suitable for both,” George adds.
One provision that was included in the original Senate bill but was eliminated before the bill passed would have aligned the limits for employer-sponsored 401(k), 403(b) and governmental 457(b) plans.
If the provision had been included in tax reform, all of these retirement plans would have a contribution limit of $18,500 in 2018, plus a $6,000 catch-up contribution for people 50 or older.
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,” says Geoff Manville, principal and leader of the government relations team at Mercer’s Washington Resource Group.
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,” Manville says. “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.”
However, he notes that he is “guardedly optimistic” because it might be revived in talks.
Senate bill provisions
There is one provision that is included in the Senate bill, though, that could have an impact on whether or not small businesses host retirement plans. The Senate’s decision to increase the deduction for qualified business income of pass-through entities from 17.4% to 23% could have the unintended consequence of making the tax incentives S Corporation owners receive to sponsor a retirement plan less attractive in a lower-tax-rate environment, according to Doug Fisher, director of retirement policy at the American Retirement Association in an analysis on NAPA.net.
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.”
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.
House bill provisions
The House proposal would eliminate the requirement that individuals take all available plan loans before they take a hardship distribution from their retirement plan, but the Senate version of the bill did not include this provision. The House bill also would eliminate the rule that prohibits participants from making contributions for six months following a hardship withdrawal.
The House bill also would provide relief from non-discrimination testing on closed defined benefit plans that meet certain conditions, but the Senate version does not.
Both bills repeal the rule allowing traditional or Roth contributions to be recharacterized as contributions of the other type.
“I think the overall message is for employers not to get too distracted yet,” George says. “There is still a lot of uncertainty, still a lot of details to be figured out. Things have moved very quickly so far. If final tax reform is passed, it will be very important for employers and their consultants and advisers to really think about benefits in a more holistic way.”
She adds that the industry has already seen this trend for some time but “tax reform would be another motivator to take more of a holistic approach to look at their benefits package across health, retirement and everything in between rather than looking at the technical compliance issues under the health umbrella or retirement umbrella.”
In the retirement space, there has been a lot of talk recently about high-deductible health plans and health spending accounts and, George says, she expects that accelerate if tax reform continues to fruition.
Robyn Credico, defined contribution practice leader, North America for Willis Towers Watson, says that when it comes to benefits, the House and Senate bills are getting much closer on what they are promising to do.