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ICMA-RC Review of Tax Reform Legislation's Potential Impact on Public Sector Retirement Plans as of December 22, 2017

December 22, 2017

President Trump signed tax reform legislation (H.R.1) into law on December 22, 2017, making the most substantial amendments to U.S. federal tax law since 1986. H.R.1 generally reduces individual and corporate income tax rates and makes substantial changes to many deductions, credits, and other provisions of the tax code. The legislation will affect many aspects of the U.S. economy, including public sector retirement plans. The following provisions would directly affect public Section 457(b) deferred compensation and Section 401(a) defined contribution plans as well as Individual Retirement Accounts:

  • Extension of Time for Terminated Employees to Repay Offset Loans: The period in which a terminated participant can roll over a loan offset to an IRA or another employer plan and avoid payment of taxes and penalties for a distribution is extended from 60 days after termination under current law, to the individual's tax return due date, including extensions, for the year in which the offset occurred. To be eligible for this treatment, the loan must have been treated as distributed from the plan solely because of the termination of the plan or the failure of the participant to meet the repayment terms of the loan because of severance of employment. In addition, the loan must have met the requirements of 72(p)(2) (i.e., the general requirements for a non-taxable plan loan).
  • Length of Service Awards for Public Safety Volunteers: The annual limit on the accrual of length of service awards for a volunteer who provides firefighting and prevention, emergency medical, and ambulance services is doubled to $6,000. There is also a cost-of-living adjustment in $500 increments based on the rules for increasing plan limits in Code § 415(d). In addition, the legislation also clarifies the method for valuing a length of service award that is paid as a defined benefit plan. In that case, the limitation applies to the actuarial present value of the aggregate amount of length of service award accruing for any year of service. To calculate the actuarial present value, reasonable actuarial assumptions must be used, assuming payment will be made under the most valuable form of payment under the plan, with payment commencing at the later of the earliest age at which unreduced benefits are payable under the plan or the participant’s age at the time of calculation.
  • Roth Recharacterizations: Recharacterization is no longer allowed in the case of a qualified rollover contribution, including a conversion, from a non-Roth account or annuity to a Roth IRA. This limitation applies to qualified rollover contributions made from pre-tax accounts under an IRA, qualified retirement plan, 403(b) plan, or 457(b) plan. The following are not affected: a) the ability to recharacterize contributions made to a Roth IRA as contributions to a traditional IRA; b) the ability to recharacterize contributions made to a traditional IRA as contributions to a Roth IRA (for individuals eligible to make a Roth IRA contribution for the year); and c) the ability to convert traditional IRAs to Roth IRAs (though individuals no longer have the ability to later recharacterize, or “undo,” that conversion).

Provisions Considered but Not Included in the Final Legislation

During the legislative process, there were a number of provisions of importance to public deferred compensation and defined contribution plans that were considered, but not included in the final legislation. While they have not become law, their prominence in the tax reform discussion may have enhanced the potential for enactment of the following at some time in the future:

  • Lower Age for Access to Section 457(b) Plan In-service Distributions: The House bill would have reduced the age at which in-service distributions from governmental 457(b) plans are allowed from 70½ to 59½, consistent with the age in which in-service distributions can be taken from 401(k) plans. Participants in public defined benefit and money purchase plans with a normal retirement age above 59½ also would have been allowed to make in-service distributions at age 59½.
  • Hardship Distributions: Expansion of Available Assets: The House and Senate bills would have expanded assets from which a 401(k) plan hardship distribution could be taken to also include: 1) employer contributions in the form of qualified non-elective contributions (QNECs) or qualified matching contributions (QMACs), and 2) earnings on contributions. While this provision would not directly address 457(b) unforeseeable emergency withdrawals, many plans follow hardship rules in administering such withdrawals. Hardship distributions are only allowed from an employee's own contributions.
  • Hardship Distributions: Elimination of Loan Requirement: The House and Senate bills would have no longer required Section 401(k) plan participants to take all available loans from the plan before receiving a hardship distribution. While this does not directly address 457(b) unforeseeable emergency withdrawals, many plans follow hardship rules in administering such withdrawals.
  • Hardship Distributions: Elimination of Six-Month Waiting Period to Re-start Contributions: The House bill would no longer restrict participants taking a hardship distribution from a 401(k) plan that follows the Treasury Department's hardship safe harbor from making contributions for the following six months. While this does not directly address 457(b) unforeseeable emergency withdrawals, many plans follow hardship rules in administering such withdrawals.
  • Aggregation of 457(b) Elective Deferrals with 401(k) and 403(b) Deferrals: The original Senate bill would have for the first time aggregated Section 457(b) plan elective deferrals at the employer level with 401(k) and 403(b) plan elective deferrals in determining whether the participant satisfies the annual elective deferral limit. Public 401(a) plans without elective deferrals would not have been affected by this change.
  • Inclusion of 457(b) Contributions in Defined Contribution Plan 415(c) Limits: Under the original Senate bill, all employer and employee contributions to any DC plan — 401, 403(b), and 457(b) — maintained by the same employer would have been required to be aggregated when determining conformance with 415(c) contribution limits. This would have for the first time included 457(b) contributions in assessing participant conformance with the 415(c) contribution limit.
  • Elimination of Special 457(b) Catch-up Contributions: The Senate bill would have eliminated the ability of governmental 457(b) plan participants to make an alternative catch-up contribution for the last three years before attainment of normal retirement age (the general catch-up limit would have been retained).
  • 10% Early Distribution Penalty Extended to Governmental 457(b) Plans: Draft legislation in the Senate Finance Committee would have extended the 10% early distribution penalty to governmental 457(b) plans, unless another exception applies.
  • Reduction to Pre-Tax Contribution Limits: Prior to the release of draft legislation, consideration was given to bifurcating contribution limits, potentially reducing pre-tax limits substantially, with remaining contributions made as post-tax Roth contributions.
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