Tax reform plan may signal future retirement savings changes

House Ways and Means Committee Chairman Dave Camp (R-MI) released a draft tax reform plan that would make significant changes to tax-advantaged savings plans, including employer-sponsored retirement plans, Traditional and Roth IRAs, and Coverdell education savings accounts (ESAs).

Chairman Camp’s draft plan, the Tax Reform Act of 2014, would significantly reduce the current income tax rates for individuals and corporations, and simplify the tax code by eliminating hundreds of popular tax credits and deductions for both businesses and individuals.

Even with the release of Chairman Camp’s plan, it is highly unlikely that comprehensive tax reform will be enacted this year. Given the political environment in Washington, few in Congress have the appetite for a major policy battle before the upcoming mid-term elections. That said, the significance of the provisions in the tax reform plan should not be overlooked. Comprehensive tax reform will occur sooner or later, and when it does, Chairman Camp’s tax reform plan could serve as the basis for future tax reform plans. In the interim, many of the proposals in the plan that raise revenue—such as the provisions to scale back tax-advantaged savings plans—could be used for deficit reduction, or to offset new government spending.

Under the draft tax reform plan, individuals would no longer be allowed to make contributions—deductible or nondeductible—to Traditional IRAs. Only rollover contributions of distributions from existing Traditional IRAs or employer-sponsored retirement plans, including savings incentive match plan for employees of small employers (SIMPLE) IRA plans and simplified employee pension (SEP) plans, would be allowed to a Traditional IRA.

The only IRA contributions allowed would be to Roth IRAs and would be nondeductible. And because the proposal would eliminate the adjusted gross income (AGI) limits on making Roth IRA contributions, all taxpayers would be eligible to make Roth IRA contributions for a year regardless of AGI. The proposal also would suspend cost-of-living adjustments to the Roth IRA contribution limit through 2023. And when cost-of-living adjustments resume in 2024, calendar year 2022 would be used as the base year for the inflation adjustment, rounding down to the nearest multiple of $500 as under current law.

The special rule that allows IRA contributions to one type of IRA (Traditional or Roth) to be recharacterized to the other type of IRA (Traditional or Roth) would be repealed. Thus, a regular Roth IRA contribution or a Roth IRA conversion contribution could no longer be recharacterized back to a Traditional IRA.

The proposal would repeal the qualified first-time homebuyer early distribution penalty tax exception and eliminate it as part of a qualified distribution from a Roth IRA. The proposal also would repeal the early distribution penalty tax exception for qualified higher education expenses.

The proposal would modify the distribution rules for nonspouse beneficiaries of IRAs and retirement plans:  It would require nonspouse beneficiaries to take distributions over a period of no more than five years, with exceptions for certain eligible beneficiaries.

Future contributions to ESAs also would be eliminated under the proposal, although rollover contributions between existing ESAs would continue to be permitted. And qualified tuition programs would be able to accept rollover contributions from ESAs on a tax-free basis.

In addition, the Tax Reform Act of 2014 would make significant changes to employer-sponsored retirement plans, including suspending the cost-of-living adjustments through 2023, and limiting elective salary deferrals on a pretax basis to one-half of the current contribution limit for plans sponsored by employers with more than 100 employees.

As previously stated, it is highly unlikely that major tax reform legislation will be enacted this year, but the significance of Chairman Camp’s proposal should not be overlooked. The message is clear that, given the cost to the Treasury, retirement savings incentives will be considered as part of any comprehensive tax reform plan. And, even without major tax reform, some of these provisions will likely be added to other legislative proposals to offset the cost of new spending.