The House of Representatives has passed its iteration of the “Tax Cuts and Jobs Act”, and while it remains to be seen if both houses of Congress can agree on a final bill, we have a good understanding already of how 401(k) plans may be impacted – as well as nonqualified deferred compensation plans.
Following much speculation on the impact tax reform might have on a participant’s ability to save for retirement on a pre-tax basis, I’m happy to report that 401(k) retirement plans survived unscathed. Unfortunately, the same cannot be said for nonqualified deferred compensation plans which are targeted to suffer under both the House and the Senate’s proposals.
Below is a high-level summary of some of the more significant provisions under both the House and Senate proposals.
401(k) Loan Repayment
Under current law, individuals with outstanding 401(k) loans who leave their jobs or are otherwise subject to plan termination are required to repay those loans within 60 days – otherwise it is treated as an early withdrawal and taxed as a distribution. A 10 percent penalty is also imposed. The House’s proposal would extend the loan repayment deadline until the due date for tax return filings for that year. In other words, an employee who leaves his/her job in 2018 would have until April 2019 to repay the balance.
IRA Conversion & Recharacterization
The House proposal seeks to permanently repeal the recharacterization of Roth IRA conversions. A Roth conversion allows a taxpayer to convert a pre-tax IRA to an after-tax Roth IRA and thus avoid minimum distribution rules and taxes on distributions after death to the beneficiary of the Roth IRA. The current recharacterization provision allows a taxpayer to undo the conversion if, for example, the investments of the Roth IRA performed poorly.
The current House proposal would eliminate the restriction preventing a participant who takes a hardship withdrawal from their 401(k) to contribute to that account for six months. In addition, under current law, participants can only take a hardship withdrawal from funds they have contributed themselves, but the House proposal would allow for the withdrawal of funds from contributions made by the participant as well as any appreciated earnings on their contributions. Furthermore, the House proposal lifts the restriction that a participant obtain all available loans under the plan before receiving a hardship distribution.
In-Service Distribution Age
The House bill proposes uniformity around in-service distributions. Tax-qualified defined benefit plans and state and local government defined contribution plans that offer in-service distributions at age 62 would have the option to lower the age limit to 59-1/2 to match their 401(k) counterpart. This could encourage participants to take distributions earlier in life. Lowering the in-service distribution age in a rising life expectancy rate environment could have adverse effects on retirement savings.
Nonqualified Deferred Compensation Plans
The most notable changes in both the House and Senate proposals stand to severely restrict many forms of nonqualified deferred compensation (NQDC) plans, as the Senate bill essentially eliminates tax deferral for most plans, including supplemental retirement plans, stock appreciation rights, and stock options under new Section 409B.
Employees and other service providers would be subject to tax when they have completed all the requirements necessary to "vest" in the future compensation, even though these amounts continue to be subject to creditor risk and are not currently payable to them. Effectively, employees and service providers would be placed on an accrual method of accounting with respect to such amounts.
The proposal would also redefine NQDC to include nonqualified stock options and stock appreciation rights, both of which would be required to be included in income when they vest versus when they are exercised or paid (current law).
While the House bill has already passed, the future of the Senate’s proposal remains uncertain, leaving the likelihood that these provisions take effect unclear at this time. If ultimately passed into law, the above changes to employee compensation plans would take effect in 2018.
For a further discussion on the House and Senate proposals as they relate to employee compensation plans, please contact us.