Feb 2, 2018
On December 22, 2017, Public Law No. 115-97, the widely debated new tax legislation, was signed into law. This law, which was originally called the Tax Cuts and Jobs Act (but that now has no official name due to procedural rules) had, at various stages of the legislative process, a great number of provisions that would have impacted retirement plans. However, the following are the only provisions in the final version of the law that we anticipate will have an impact (direct or indirect) on retirement plans:
- Disaster relief for major disasters occurring in 2016
- Extension of the time period for rolling over certain loan offset amounts
- Prohibiting the re-characterization of IRA conversions and amounts rolled over to IRAs
- Changes to hardship distributions for casualty losses
A brief summary of these provisions is set forth below.
Disaster Relief. Back in September of 2017, Congress passed the Disaster Tax Relief and Airport and Airway Extension Act of 2017, which relaxed the rules regarding qualified plan distributions and loans in order to help individuals affected by three major 2017 hurricanes (Hurricanes Harvey, Irma and Maria). The new tax law provides similar, but more limited, relief (described in the next paragraph) for distributions taken in 2016 or 2017 by individuals affected by events that were declared major disasters by the President during 2016 (e.g., the Tennessee wildfires, Hurricanes Hermine and Matthew, etc.) A complete list of 2016 major disaster areas can be found at www.fema.gov/disasters
. Specifically, the new law allows qualified plans, tax-sheltered 403(b) annuity plans, and eligible governmental 457(b) plans to treat up to $100,000 of distributions made during 2016 and 2017 to individuals (i) whose principal residence was in an area that was declared a major disaster area in 2016 and (ii) who sustained an economic loss from the disaster, as “Qualified 2016 Disaster Distributions.”
Qualified 2016 Disaster Distributions are not subject to the 10% early payment penalty tax that generally applies to distributions made prior to age 59-1/2, can be taken into income by the individual ratably over a three-year period, and can be repaid to the plan during the three-year period beginning on the day after the date the distribution was received. Any amounts that are timely repaid can be excluded from income altogether, as though they were originally rolled over to an eligible plan. To the extent a plan permitted distributions not otherwise permitted under plan terms to assist participants with needs arising due to a major 2016 disaster, the plan document must be amended to reflect its operation no later than the end of the first plan year beginning on or after January 1, 2018.
Extension of Rollover Period for Certain Loan Offset Amounts.
When a participant defaults on a plan loan, the outstanding balance of the loan at the time of default becomes taxable income and is reported as such on IRS Form 1099-R. If the participant is not eligible for a distribution from the plan at the time of default, the loan remains an asset of the participant’s account and the taxable event is known as a “deemed” distribution. However, if the participant is eligible for a distribution from the plan at the time of default, the participant’s account balance may be reduced (“offset”) by the loan asset and the taxable event is treated as an actual distribution, even though no cash is involved. As an actual distribution, the amount of the loan offset is eligible to be rolled over to an individual retirement arrangement or other tax-qualified retirement vehicle. By rolling over the loan offset amount, a participant can avoid having to include the value of the outstanding loan balance in income. Of course, because the offset doesn’t involve any cash, the participant must use personal funds to make the rollover.
Under prior law, participants had just 60 days to accomplish a rollover of a loan offset amount. Under the new tax law, the rollover period has been significantly extended for loan offsets occurring after December 31, 2017, under qualified plans and annuities, tax-sheltered 403(b) annuity plans, and governmental 457(b) plans, if
the loan offset occurs in connection with the termination of a plan or a participant’s failure to repay a loan at termination of employment. For these loan offsets, participants can roll over personal funds equal to the loan offset amount up until the due date (including extensions) for filing his or her tax return for the year the loan offset occurs.
No Re-characterization of Roth Conversions.
Under prior law, an individual who converted a traditional individual retirement arrangement (“IRA”) to a Roth IRA, or who rolled non-Roth funds from a retirement plan to an external Roth IRA, could rescind the transaction up until the due date (plus extensions) for filing his or her tax return for the year. The rescission was known as a re-characterization, and allowed the individual to avoid having to pay the income taxes that would otherwise have been due on the amount converted or rolled over. Starting in 2018, these re-characterizations are no longer permitted. This change does not directly affect employer-sponsored retirement plans (unless the plan has a deemed IRA feature); “internal” Roth conversions inside an employer-sponsored retirement plan (i.e.
, where non-Roth sources held in the plan are converted to Roth sources in the same plan) have never been eligible for re-characterization. The IRS has clarified on its website that the new law does not prohibit re-characterizations in 2018 of conversions or rollovers initially made in 2017 as long as the re-characterization is made by October 15, 2018 (https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-recharacterization-of-roth-rollovers-and-conversions)
Under the new tax law, between 2018 and 2025, taxpayers may generally no longer claim deductions for personal casualty losses, unless those losses are attributable to a federally declared disaster. Most qualified 401(k) plans, and many other types of employer-sponsored retirement plans, have adopted “safe harbor” hardship distribution provisions that include as a permissible hardship event the need to repair damage to a principal residence that would qualify as a casualty loss. It appears that for hardship distribution purposes, only repairs for casualty losses attributable to a federally declared disaster would now be permitted, to the extent the plan uses the safe harbor hardship distribution rules, at least until guidance is issued to the contrary.
Because the tax law is new, it is possible that there are other provisions that may indirectly impact employer-sponsored retirement plans. Newport Group will continue to monitor the law and any guidance issued by applicable governmental agencies, and let our clients know of any major developments that impact retirement plans. In the meantime, if you have any questions regarding this summary or your retirement plan, please contact your Client Relationship Manager.