After many rounds of negotiations, Congress passed the Tax Cuts and Jobs Act on December 20th, 2017.  Though retirement plan limit reductions were included in many iterations of the bill, the ultimate effect on qualified plans was relatively minimal.  There are two items of note that were included in the new law affecting loan repayments and IRA conversions.

401(k) Loan Payback Period gets extended!

Many defined contribution plans include provisions for a participant to take a loan from their retirement account.  The loan is generally limited to 50% of a participant’s vested account balance with a maximum of $50,000.  The term for repaying a participant loan is typically 5 years and is repaid through payroll deductions.  But, what happens to the outstanding loan balance if the participant terminates employment and payments through payroll are not an option?  More times than not, the remaining balance is deemed to be in default and the participant will pay taxes, and possibly penalties, on the amount in question.  In order to avoid defaulting on the loan, the participant must repay the balance within 60 days of the default date to either an IRA or another qualified retirement plan.

This is no small matter.  According to a report published by the Pension Resource Council, the default rate for employees terminating with a loan balance was over 80%! Not only does this create a tax burden on the participant, it also depletes the total funds that they had previously saved for retirement.  The recent Tax Cuts and Jobs Act includes language that has loosened the repayment requirements for participants, giving them more time to repay the loan and avoid unnecessary taxation.  Under the new law, the 60-day rollover period has now been extended to the due date of the participant’s income tax return (including extensions) for the year in which the default occurred.  For example, if a participant took a distribution in January 2018, under the new law, they would have until April 15, 2019 to repay the defaulted loan balance, or even October 15, 2019 if their tax returns were extended.  Instead of 60 days, now participants potentially have up to 21 months to repay these defaulted loan amounts.  

Recharacterizations of IRAs… Can I take a mulligan?

Prior to 2018, retirement savers who have utilized traditional pre-tax IRAs have had the right to “convert” all or part of these accounts to a post-tax Roth IRA. The move required that the individual pay the income tax due on the amount converted.  The advantage for the taxpayer was that the Roth IRA would continue to grow tax free.  

Before the Tax Cuts and Jobs Act, if a conversion was found to be undesirable from a tax standpoint by October 15th of the year following the conversion, it could be recharacterized back to its tax deferred status and continue as a pre-tax IRA.  The change could be for any reason, but typically it was reconsidered when either the final tax liability for the individual was higher than anticipated or, due to market decline, the individual could be paying taxes on a diminished amount. Regardless of the situation, the new law eliminates recharacterization so there are no longer any “do-overs”. For conversions that occurred in 2017, the recharacterization is still available through October 15, 2018.

Finally, here are a few items that were not included in the new law.  Retirement plan changes proposed in the original House version of the bill, such as lowering the age for in-service distributions from pension plans and easing rules on hardship distributions, did not make it into the final legislation. The new law also does not eliminate the life expectancy payout method for retirement plan death benefits, nor does it impose lifetime RMD requirements on Roth IRAs. Though it seemed to be supported, these provisions did not make the final bill.

This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.