In late December, President Trump signed into law H.R.1 (now Public Law No. 115-97), which has made the most sweeping changes to the tax code since the Tax Reform Act of 1986. Unlike 1986—which placed limits on IRA deductibility for many middle- and upper-income individuals—retirement plans were spared in the latest tax overhaul, with no significant changes to retirement plan contributions or benefits. And the good news for credit unions and their members is that the credit union tax-exemption remains in place and changes to IRAs are minimal.
Following is a summary of the IRA provisions in the final tax reform bill.
- The ability to recharacterize a conversion to a Roth IRA is eliminated. As a result, transactions converting Traditional IRA assets to a Roth IRA or rolling over employer-sponsored retirement plan assets to a Roth IRA are now final. Recharacterizing annual IRA contributions is still permitted, so contributions to a Roth IRA can be recharacterized to a Traditional IRA, and contributions to a Traditional IRA can be recharacterized to a Roth IRA under the current recharacterization rules. This provision is effective for tax years beginning after December 31, 2017.
- The formula used for calculating the annual cost-of-living adjustments for IRAs, health savings accounts (HSAs), Archer medical savings accounts (MSAs), and the Saver’s Credit is changed. The change means that cost-of-living adjustments will occur less frequently than under the current formula. This provision is effective for tax years beginning after December 31, 2017.
- Special retirement plan-related relief is made available to eligible victims of any 2016 presidentially-declared disasters. The relief is provided retroactively and includes exempting qualifying distributions before age 59½ of up to $100,000 from employer-sponsored retirement plans and IRAs from the 10 percent early distribution penalty tax. The relief allows for repayment of qualifying distributions within three years, providing for special tax treatment of qualifying distributions not rolled over, and waiving otherwise-mandatory withholding on qualifying distributions. This provision is effective as of the date of enactment, applicable to distributions on or after January 1, 2016, and before January 1, 2018.
Passage of the comprehensive tax reform bill gives President Trump his first major legislative victory and fulfills one of his key campaign promises. In order to get the final bill to the President’s desk for his signature, the House and Senate worked in conference committee to reconcile the differences between the original House bill and the bill passed by the Senate in early December.
The final bill modified the House and Senate provision to eliminate recharacterizations completely by continuing to allow recharacterizations of annual IRA contributions under the current recharacterization rules. The final bill also left out two other provisions in the original House bill that would have affected MSAs and Coverdell education savings accounts (ESAs) as follows.
- The deduction and exclusion for contributions to MSAs would have been eliminated. Contributions to MSAs would no longer be permitted and employer contributions to employees’ MSAs would no longer be excludable from income.
- Contributions to ESAs would have no longer been permitted. Existing ESAs could remain in place and existing ESA balances could still be rolled over to another ESA or to a state-sponsored 529 savings program. Note that under the final bill, state-sponsored 529 plan assets can now be used for elementary and secondary school tuition, up to $10,000 per year.
Eliminating the ability to recharacterize a conversion to a Roth IRA creates a significant tax-trap for the unwary, but in retrospect, it is a small price to pay given the minor changes that the final tax reform bill makes to retirement plans.
Neither the original House bill nor the Senate bill, or the final bill contained the “Rothification” provision that was rumored prior to release of the tax bills, which would have treated some or all retirement plan contributions as after-tax contributions, like Roth 401(k) and Roth IRA contributions are currently treated. And there is no reduction in the annual contribution limits for 401(k) plans and IRAs, no caps on tax-advantaged retirement savings plan accumulations, and no limits on tax deductibility that had been proposed in the past.
Many in the industry were worried that tax-advantaged savings plans would be sacrificed to pay for tax reform, given the cost of the plans to the Treasury, which is second only to the cost of employer-provided health insurance. This time around these concerns proved to be unfounded.
As IRA trustees and custodians, we can all breathe a collective sigh of relief, not for what we got from the tax reform bill, but for what we didn’t lose. The significance of this to credit unions and their members should not be taken for granted. That said, Congress intends to work on a technical corrections bill to make minor fixes to the final tax reform bill. Stay tuned.