GOP Tax Reform and Retirement Accounts

Its official: We have tax reform. But, how does it affect your IRAs, 401(k)s, 529s, Coverdells, and other retirement and education savings accounts? Let’s break down what’s new, what was proposed and didn’t make it, and what stays the same.

New Changes for 2018

There are two major changes effecting retirement, health, and education savings accounts in the bill:

1. Roth re-characterizations are dead.

Account holders will no longer be able to conduct what is known as a Roth re-characterization. A Roth re-characterization occurs when you convert from a Traditional IRA to a Roth IRA, and then later decide that you would like to go back. This helped those who couldn’t pay the tax on the conversion, or those who saw their account value go down after the conversion as they were able to undo the conversion, wait a period of time, and then reconvert and alter tax years at a lower value. The strategy will still be allowed for those who converted in 2017 and want to undo in 2018, but is unavailable after that. For my prior article outlining how the Roth re-characterization works please refer to my article here.

2. 529s can be used for K-12 private school.

College savings plans known as 529s have been expanded, and can now be used for K-12 expenses up to $10,000 per year. 529 plans remain unchanged as to college expenses, and the $10,000 cap only applies to K-12. Although you do not get a deduction for 529 plan contributions, 529 plans allow for tax-free growth and the funds can be used for education expenses. For a summary of 529 plans, and the differences between 529s and Coverdell ESAs (aka Coverdell IRAs) please refer to my prior article here.

What Was Proposed and Didn’t Make It in the Final Bill

There were a number of proposals that were part of one bill, but were removed before passing through Congress and getting signed by President Trump. These proposals include:

1. Ending Coverdell ESAs (aka Coverdell IRAs).

This proposal was part of the House bill – not included in the Senate bill – and, in the end, changes to Coverdell accounts were removed from the final bill. This is good news as Coverdell ESAs have been used by many as a means to save for their kids’ or grandchildrens’ college expenses. Similar to a 529, there is no tax deduction on contributions, but the funds grow tax-free and are used for college education expenses. The nice thing about a Coverdell, as opposed to a 529, is that you can decide what to invest the account into whether they are stocks, real estate, private companies (LLCs, LPs), or cryptocurrency.

2. Restrict deductible traditional retirement plan contributions.

There were proposals to restrict deductible traditional retirement plan contributions and to force the majority of 401(k) or other employer plan contributions to be Roth. The goal: Raise revenue now. Thankfully, these proposals never made it into the House nor Senate bills.

There were some minor hardship distribution changes for employer plans but other that the items outlined above, Tax Reform was neutral on retirement plans and savings for Americans and sometimes that’s the best you can hope for.

3 Year-End IRA Tips

vgsgn1482893180It’s the end of the year and many IRA investors are stressing about what they need to do by December 31, 2016. Here’s what you need to know for your IRA as it relates to year-end.

1. 2016 Contribution Deadline. First, the good news. You don’t have to make your 2016 contributions by year-end. You have until April 18, 2017 to make your traditional IRA, Roth IRA, or SEP IRA contributions for 2016. Check out the “IRS Year-End Reminders for IRAs” here for more details.

2. Roth Conversions. If you are planning to convert traditional IRA dollars to Roth for 2016, then you must make that conversion by December 31, 2016. If you convert in 2016 (by 12/31/16), then the amount you convert will get reported on your 2016 tax return. For those that have a down year or that simply want to start down the path of moving funds from traditional (tax-deferred funds) to Roth (tax-free), you’ve got to jump on this now. Your IRA custodian will typically have a Roth Conversion form that you complete and return to them. If you are converting cash, then the process is pretty simple as the value of the conversion is the cash amount. If you have a self-directed asset such as real estate or an LLC interest, you will need an appraisal or valuation of that asset in order to convert it to Roth. And lastly, if you’re on the fence about doing a Roth conversion because you’re worried about how much it will cause you in taxes, the IRS allows you to un-do the Roth conversion later in 2017, your funds go back to traditional funds, and you don’t have to pay the tax. This is one of the few things the IRS let’s you un-wind. Check out my prior article on Roth re-characterizations here.

3. The Over 70 1/2 Club. For those over 70 1/2 with traditional IRAs, you are required to take required minimum distributions (“RMD”) from your account each year. The deadline for 2016 RMDs is December 31, 2016. There is a 50% excise tax penalty for failure to take RMDs. In other words, if you don’t distribute the money to yourself from your IRA in time, the IRS will just take half of it to penalize you. Those with Roth IRAs need not worry as Roth IRAs are exempt from RMD. I’ve explained the facts and fiction on RMDs in a prior article you can find here.

So, if you’ve got a Roth conversion or RMD to take for 2016, you better get your “IRA” in gear. If you’re wondering about IRA contributions, don’t worry, you’ve got until April 18, 2017 to make them.