Assistant Vice President and ERISA Attorney, Benefits Consulting Group, John Hancock Retirement Plan Services
The Tax Cuts and Jobs Act (the “Act”), which was signed into law by President Trump on December 22, 2017, will impact qualified retirement plans in a variety of ways. While these impacts aren’t major, let’s look at four things we have learned so far.
1. The anticipated “Rothification” of 401(k) contributions failed to materialize.
One widespread fear was that post-tax contributions could replace pre-tax contributions in whole or in part. Fortunately, this change didn’t come to fruition. As a result, plan participants are free to continue their contributions on a pre-tax (and/or Roth) basis, subject to the current limits.
2. There is now a longer rollover window for 401(k) borrowers.
Employees who separate from service with an outstanding plan loan balance now have until their annual income tax due date (including any extensions) to effectuate a rollover—and thus avoid the hassle and expense of a loan offset. This extension also applies to a participant with an outstanding loan from a plan that’s been terminated.
3. There’s also new tax relief for certain distributions due to a presidentially declared disaster.
This relief applies to individuals with principal residence in an area hit by a presidentially declared disaster in 2016, and who incurred an economic loss due to the event. Specific relief measures—which apply to certain retirement plan and IRA distributions taken over the past two years up to an aggregate distribution amount of $100,000—include:
An exception to any 10% early distribution penalty
Exemption from any 20% mandatory tax withholding
Ability to spread the taxable amount over a three-year period—or to roll over any such distribution within three years
See similar provisions for the more recent California wildfires
4. The tax act precludes the ability to recharacterize (or unwind) Roth IRA conversions.
This applies to any conversion completed after December 31, 2017.
5. New deductions for business owner income may not pose a major threat to qualified plans.
One provision that got our close attention is the deduction given to certain pass-through entities (including partnerships, S corporations, and sole proprietorships). Under the Tax Cuts and Jobs Act, the owners of such entities may deduct an amount equal to 20% of the entities’ “qualified business income” on their Federal income tax returns.
This deduction could arguably serve as a disincentive for adopting or continuing to
maintain a 401(k) or other qualified retirement plan. Why? In theory, a business owner could
surmise that the distributions they might collect in retirement would be taxed at a rate higher than their current “qualified business income” rate.
That said, such an argument fails to account for the ancillary benefits that a company derives from maintaining a qualified plan—most notably, the ability to attract and retain employees. It also throws aside the power of years, even decades, of potential compounded growth.
And as for any potential disadvantage to an owner-employee due to a potentially higher tax rate in retirement, the answer could be as simple as choosing Roth contributions in lieu of pre-tax deferrals.
To arrange a consultation about the effects of recent legislation and regulations on your retirement plans, contact your John Hancock representative.
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