Tax Reform Spares Retirement Savings

The bill preserves virtually all the features and benefits that we’re familiar with, but does affect some retirement and tax-advantaged savings arrangements.  

Have you been wondering how tax reform will affect tax-advantaged retirement accounts?  While the recently passed Tax Cut and Jobs Act law makes significant changes to both individual and corporate tax rate, changes to tax-advantaged accounts are only modest. However, before breaking down the changes, let’s cover what strategies were not included in the bill.

High-income earners can still use the “Back-door Roth.” In addition, there were no changes to inherited IRAs, thus continuing to allow for the post-death “stretch” payout. Finally, there were no fundamental changes to qualified plan contribution limits or benefits, including to the popular 401(k) plan, its contribution limit and/or funding method. In 2018, 401(k) participants can continue contributing pre-tax, Roth, or a combination thereof to their 401(k), 403(b) or 457(b) plans up to the annual limit of $18,500 of their account. In other words, the final bill does not include a provision to “Rothify” 401(k) plans.

“Remember where we started,” noted Brian Graff, CEO of the American Retirement Association. “There were proposals on Rothification, cutting or freezing retirement plan contribution limits, eliminating 403b and 457 plans, and basically eliminating all forms of nonqualified deferred compensation. In the end, we were able to beat back all of those.”

Here is a brief listing of the retirement related provisions.

Elimination of Recharacterization of Roth Conversions
Currently, an individual can rollover (e.g., convert) traditional IRA funds to a Roth IRA and then at a later date reverse or undo the conversion by transferring the proceeds back to a traditional IRA by their tax return due date plus extension. This technique is called a recharacterization. Effective for tax years beginning after December 31, 2017, the bill eliminates an individual’s ability to recharacterize a conversion to a Roth IRA. As a result, converting traditional IRA dollars (including SEP and SIMPLE) assets or rolling over employer plan assets to a Roth IRA will be irrevocable. Notably, contributions to a Roth IRA can still be recharacterized as traditional IRA contributions for the same tax year and vice versa. For example, an individual may make a contribution for a year to a Roth IRA and, afterwards while meeting with their accountant it’s determined due to their income they’re ineligible to make Roth IRA contributions. In this situation, the individual can recharacterize the contribution to a traditional IRA so long as the transaction is completed before the due date for the individual’s income tax return for that year.

Extension of Time to Roll Over Plan Loan Offsets
Presently should a participant have an outstanding plan loan when upon separation from service or plan termination, typically the employer “offsets” the employee’s account balance by the unpaid loan balance, resulting in potential taxation and penalties. However, the participant avoids taxation by contributing the amount of the outstanding loan balance to an IRA or new plan within 60 days of separating from the employer. Effective for taxable years beginning after 2017, the rollover deadline is extended to the due date of the employee’s tax return plus extension.

Length-of-service Awards for Public Safety Volunteers
The maximum amount for the exception to Internal Revenue Code section 457 for a length of service award plan providing awards to bona fide volunteers has been $3,000.The final bill raises the maximum amount for a length-of-service award plan to $6,000 and indexes that amount going forward, effective for tax years beginning after 2017.

529 Plans
The bill gives parents who enroll their children in private school (elementary and high school) additional tax advantaged savings options. Currently, Coverdell Education Savings Accounts (ESAs) were the only savings vehicles that offered the potential for tax-free withdrawals to pay for K-12 expenses. The bill includes a welcome provision expanding qualified tax-free 529 plans withdrawals up to $10,000 per year to pay for K-12 expenses, giving more families an opportunity to save tax-free for private and religious schools. Currently, 529 plans offer tax-free earnings growth and tax-free withdrawals only for college expenses. Notably, parents who are currently saving using a Coverdell ESA can rollover the proceeds to a 529 without being subject to taxation.

ABLE Accounts
For distributions, amounts from qualified tuition programs (also known as 529 accounts) are allowed to be rolled over to an ABLE account without penalty, provided that the ABLE account is owned by the designated beneficiary of that 529 account, or a member of such designated beneficiary’s family. ABLE accounts were first introduced in 2014, to help individuals living with disabilities save for education and other living expenses. Moreover, ABLE account contributions by the ABLE account beneficiary will be eligible for the saver’s credit.

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

A SIMPLE IRA plan is an IRA-based plan that gives small-business employers a simplified method to make contributions toward their employees’ retirement and their own retirement. Under a SIMPLE IRA plan, employees may choose to make salary reduction contributions and the employer makes matching or nonelective contributions. All contributions are made directly to an individual retirement account (IRA) set up for each employee (a SIMPLE IRA). SIMPLE IRA plans are maintained on a calendar-year basis.

A simplified employee pension plan (SEP IRA) is a retirement plan specifically designed for self-employed people and small-business owners. When establishing a SEP-IRA plan for your business, you and any eligible employees establish your own separate SEP-IRA; employer contributions are then made into each eligible employee’s SEP IRA.

A 401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

A 403(b) plan is a retirement savings plan that allows employees of public schools, nonprofit, and 501(c)(3) tax-exempt organizations to invest on a pretax and or Roth aftertax basis. Contributions to a 403(b) plan are conveniently deducted directly from your paycheck. In addition, your employer may elect to make a contribution on your behalf.