What Might Tax Reform Mean For Your Retirement Account?

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November 16, 2017 6:15am NASDAQ:QQQ


From Invesco: On Nov. 2, House Republicans unveiled their long-awaited tax reform proposal (the Tax Reform and Jobs Act), which calls for substantial tax cuts, offset in part by the elimination or modification of numerous tax incentives.

Not included in the bill were rumored “Rothification” changes that would have reduced the tax incentives enjoyed by many retirement savers — forcing some or all new individual retirement account (IRA) and employee 401(k) and 403(b) contributions to be made on an after-tax basis into Roth accounts, rather than on a traditional pre-tax basis. However, several technical changes were made to certain plan and IRA features.

Retirement provisions in the House bill

Roth recharacterization

Under the bill, IRA holders would no longer be able to recharacterize traditional IRA contributions as Roth contributions, or do the reverse, as currently permitted. Further, savers would no longer be able to reverse traditional IRA-to-Roth IRA conversions.

In-service distributions from pension plans and governmental 457(b) plans

Under current law, a pension plan (i.e., a defined benefit [DB] plan or a money purchase plan) generally may not allow in-service distributions before the earlier of normal retirement age under the plan and age 62. The bill would reduce this to the earlier of normal retirement age and age 59½. In addition, a governmental 457(b) plan generally may not make in-service distributions until age 70½, which the bill would lower to 59½.

Hardship withdrawals

The House tax reform bill would ease some restrictions on 401(k) hardship distributions. First, the proposal would do away with a six-month restriction on contributions for participants who take hardship withdrawals. Second, the bill would allow employers to use their discretion regarding whether the distributions can include employer contributions and investment earnings; currently, distributions can only include employee contributions.

In addition, Treasury regulations generally require that a participant take all available loans from the retirement plan before a hardship distribution is allowed. The House bill would eliminate this requirement.


Retirement plan loans are considered immediately due and payable when a participant terminates employment; the participant has 60 days to completely pay off the loan to avoid taxes and penalties on the loan amount. The House plan would extend the repayment period until the due date for filing their tax return for the year (including extensions).

Nondiscrimination testing for closed DB plans

Employer-sponsored retirement plans must currently satisfy rules to ensure that the benefits provided under the plan do not discriminate in favor of highly compensated employees. Certain employers have closed their DB plan to new employees but have allowed existing employees to continue to accrue benefits — arrangements that have, over time, bumped up against the nondiscrimination rules. The House bill would provide nondiscrimination testing relief to certain employers with closed DB plans, provided they give new employees an increased benefit in a DC plan.

Effect of pass-through business rates on retirement plan incentives

Prior to the House bill’s release, there had been concern in the retirement industry that the rumored reduction in the tax rate on pass-through business income could have a negative impact on the incentives for small-business owners to establish and maintain a retirement plan. If the business owner’s retirement contributions are deducted at 25%, but taxed at 35% or 39.6% when withdrawn, this would undermine the economic incentives for the business owner to establish and save in a retirement plan. Some observers are initially optimistic, though, because the House bill’s treatment of pass-throughs came with several restrictions, so that retirement incentives appear to remain in place for business owners.

Retirement provisions in the Senate’s conceptual framework

The Senate tax reform framework (which is not in bill form) was released on Nov. 9. Similar to the House bill, it does not divert contributions from traditional accounts to Roth accounts. It does, however, contain several limitations and plan consolidation proposals.

Catch-up contributions

Individuals could not make any catch-up contributions — even on an after-tax basis — for a year if they received wages of $500,000 or more in the preceding year.

403(b) and 457(b) plans

The proposal would coordinate the $18,000 deferral limit on 457(b) plans with the same limit on 401(k) and 403(b) plans, so that an employee would get a single $18,000 limit under any combination of the three plans. It would also subject 403(b) and governmental 457(b) plans to the private sector employer aggregation rules for purposes of the limits on contributions.

Other plan consolidation proposals include:

  • Elimination of the exemption for the 10% early distribution tax for governmental 457(b) plans.
  • Elimination of the special 403(b) and 457(b) catch-up rules.
  • Elimination of the special rule permitting 403(b) contributions for former employees.
  • Counting 457(b) contributions toward the 415 annual additions limit.

Nonqualified deferred compensation

An employee would be taxed on compensation as soon as there is no substantial risk of forfeiture with regard to that compensation. This would have the impact of making wholesale changes to the taxation of virtually all nonqualified deferred compensation by taxing amounts earned under those plans as they vest, rather than when they are paid. This is almost identical to a provision in the original House proposal that was deleted in a subsequent amendment.

Next steps

The outcome of tax reform is far from certain. There remains some concern in the retirement industry that “Rothification” might yet make it into a final version.

The House proposal was approved by the Ways and Means Committee on Nov. 9 by a 24-16 vote along party lines. The full House is expected to vote on the package later in the month. Meanwhile, the Senate Finance Committee began marking up the Senate version on Nov. 13, with a vote planned for after Thanksgiving. We’ll keep you posted.

The PowerShares QQQ ETF (QQQ) rose $0.67 (+0.44%) in premarket trading Thursday. Year-to-date, QQQ has gained 29.41%, versus a 15.78% rise in the benchmark S&P 500 index during the same period.

QQQ currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #1 of 36 ETFs in the Large Cap Growth ETFs category.

This article is brought to you courtesy of Invesco.

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