Tax Bill Affects IRA Conversions, Loans, 529s, NQDC Plans

The tax bill currently awaiting President Trump’s signature does not fundamentally change the tax breaks retirement plan participants receive, according to a law alert that The Wagner Law Group issued.

However, the Tax Cuts and Jobs Act does make some changes to Employee Retirement Income Security Act (ERISA) plans, including 529 college savings plans, and nonqualified deferred compensation (NQDC) plans. The tax bill will continue to allow taxpayers to recharacterize contributions made to a Roth individual retirement account (IRA) as contributions to a traditional IRA, as long as it is done before the due date of the taxpayer’s income tax return, including any extension. Importantly, this will not apply to the reverse situation, where an investor would take traditional IRA contributions and then recharacterize them as Roth.

Currently, if an employee has taken out a loan from their retirement plan and has an outstanding balance when leaving the company, they have up to 60 days to roll over the outstanding loan balance to an IRA to avoid having the loans treated as taxable distributions. The tax bill extends this rollover period to the due date for filing their tax returns.

College savings plans are now amended to permit 529 account owners to take a $10,000 distribution each year and apply it not just to college expenses but also to public, private or religious elementary or secondary schools. The tax bill also permits rollovers from a 529 plan to an ABLE program, which is a tax-favored savings program for disabled individuals, as long as that program is owned by the designated beneficiary or a member of his or her family.

With respect to nonqualified deferred compensation (NQDC) plans, the bill modifies the definition of a “covered employee” at a publicly traded company, for whom an annual deduction up to $1 million applies. A covered employee includes the principal executive officer and principal financial officer, as well as the next three highly compensated employees, during the tax year. Furthermore, if an individual was a covered employee at a company in a taxable year after December 31, 2016, they will be considered to be a covered employee for all future years.

The bill also extends the application of this NDQC feature to include all foreign companies publicly traded through American depository receipts (ADRs) as well as certain types of large organizations that are not publicly traded, such as large private C or S companies. The bill eliminates commission and performance-based exclusions.

A tax-exempt organization will be subject to a 21% excise tax on any payment in excess of $1 million paid to its highest paid employees, and any excess parachute payment. An excess parachute payment is redefined as one exceeding three times the average annualized compensation for the five years preceding separation of service. With regard to transfer of employer stock to an employee in connection with their performance, the employee can defer,  for income tax purposes, the income attributable to the stock, but this must be done no later than 30 days after the stock is vested or becomes transferable, whichever comes first.

Offering additional commentary, the tax and accounting division of Thomson Reuters notes that the legislation allows 401(k) plans and other eligible retirement plans to help victims of federally declared major disasters occurring in 2016 by allowing “qualified 2016 disaster distributions” of up to $100,000 per individual prior to January 1, 2018. Such distributions are not subject to the 10% additional tax on early withdrawals.

Professor Jamie Hopkins, co-director of the retirement income program at the American College of Financial Services in Bryn Mawr, Pennsylvania, notes that while the 401(k) savings cap and Rothification of accounts did not end up in the final bill, neither did any additional measures to help Americans to save more for retirement. She says the removal of recharacterication of IRAs to Roth IRAs will discourage people from investing in Roth IRAs, since recharacterizations allowed them to undo conversions.

However, Tim Slavin, senior vice president at Broadridge, sees a number of positives for retirement plan participants. Most notably, he says, lowering the tax brackets for middle- and lower-income Americans could go a long way to motivate people who are not currently contributing to their 401(k) plan to sign up, or for those who are already in the plan, to increase their contributions. He also likes the flexibility being added to 529 plans. He thinks the new provisions will increase ownership and assets in 529 plans.

And the extension of time people are being given to repay outstanding loans without having the distribution being treated as taxable income is another improvement Slavin applauds. As he notes, “There are a lot of loans out there.”