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.
How does the proposed Republican tax reform impact your retirement account? Well, if you save for education expenses for your kids or grand-kids using a Coverdell Education Savings Account, you’re not going to be happy as new contributions to Coverdell accounts are eliminated in the House Plan. Also, both House and Senate bills eliminate the ability to re-characterize Roth IRA conversions back to Traditional IRAs. This was a nice “do-over” the IRS allowed you to use if you regretted converting your Traditional IRA to a Roth IRA, and switched it back to a traditional IRA within certain time limitations. For my prior article on how a Roth IRA re-characterization works, at least for now, check it out here.
The only good news: It could’ve been worse. There was talk of drastic changes that would have essentially called an end to Traditional IRA and 401(k) contributions in favor of Roth-only contributions (or limiting Traditional dollars to $2,400 annually). Luckily, those ideas never made it into the legislation.
Here’s a brief summary of the two major changes effecting IRAs. In addition to the changes effecting IRAs, there are numerous proposals regarding employer retirement plans such as 401(k)s, but those changes only slightly alter the ways those plans function.
|Source ||Change to IRAs||Effect|
|House Bill||No More Coverdell Education Savings Accounts (ESAs) Contributions||Coverdell accounts are used as a vehicle to contribute funds (up to $2k annually per beneficiary) for education expenses. It is usually used by parents or grandparents as an account to invest the money tax-free whereby the money in the account grows without being subject to tax and comes out tax-free for the beneficiary’s education expenses. There is no deduction for the contribution. The current proposal would eliminate the ability to make future Coverdell contributions. Existing accounts may still exist without new contributions or may be rolled to a 529.|
|House Bill & Senate Amendment to Senate Bill||End Roth IRA Re-characterizations||Under current rules, you can convert your traditional IRA to a Roth IRA, and if you later decide that such conversions (and tax due) wasn’t a good idea, you are allowed to undo the conversion and go back to a Traditional IRA.|
So what should you do now? If you’ve used Coverdell accounts or wanted to, make 2017 Coverdell contributions because they may be the last time you can do them. Also, if you’ve been thinking of converting a Traditional IRA to a Roth IRA, 2017 may be the last year you can do so, and still have the ability to re-characterize back to Traditional if you later decide against it.
The RISE Act proposed by Senator Ron Wyden of Oregon would significantly impact self-directed IRAs. I previously wrote about the bill here and provided a detailed analysis. In summary, the bill would require that all self-directed IRA investment purchases be valued by a third-party appraiser and reported on the IRA owner’s personal tax return. In addition, the Act would change the disqualified person rule for companies from 50% to 10%. The Act also greatly effects Roth IRAs and would eliminate Roth conversions and would cap Roth IRA accounts at $5M.
Here are few quick updates that are very important to the bill.
- Senator Orrin Hatch of Utah (R) has introduced the Retirement Enhancement and Savings Act of 2016. This bill is farther long in the process and addresses retirement account issues but is entirely un-related to Senator Wyden’s proposed RISE Act the impacts self-directed IRAs. I’ve had a few clients worried as they’ve ran across this bill as it is currently working its way through the Senate.
- Senator Wyden’s RISE Act is in proposed form and is out for comment until December 7, 2016. You can reply with comments to Retirement_Savings@finance.senate.gov. I will post my Comment in a subsequent blog article.
- While the bill is sponsored by Democrat Senator in a Republican controlled Senate, it is still vitally important that the Senate Finance Committee understand the roadblocks and burdens that the bills IRA provisions will cause to hundreds of thousands of Americans who are investing for retirement with their self-directed IRA.
- If your Senator is a member of the Senate Finance Committee, I would highly recommend sending focused and professional comments to your Senator regarding provisions that will hinder your ability to save and invest for retirement. The current members of the Senate Finance Committee can be found here.
Additionally, if you have comments or feedback relative to the proposed bill, please feel free to that to me at email@example.com.
The Retirement Improvements and Savings Enhancements Act (“RISE Act“) has drastic changes and provisions that effect self-directed IRA investors. From mandatory third-party valuations on all retirement account investment transactions to changing the 50% disqualified company rule to 10%, the bill has some significant changes that will negatively affect your ability to self-direct your account. There are some favorable provisions for IRA owners, however, the negatives greatly outweigh the positives.
Most Important Provisions
The bill sponsor is Sen. Ron Wyden (D-OR) who is the Ranking Member of the Senate Finance Committee and the Joint Committee on Taxation. Here’s a quick run-down of the most troublesome provisions that apply to self-directed IRA investors:
- Valuation Purchase/Sale Requirement. Mandatory Valuation Requirement for Private IRA (non-public stock market) Transactions: The new proposal seeks to require gifting valuation rules and standards for IRA transactions. This rule will force IRA owners to get a valuation before making any private investment. This valuation would include real estate, private company (e.g. LLC, LP, corporation), and note investments. The gifting valuation rules were created to value gifts where no value is set between a buyer and seller. mandating those same rules on actual transactions between an IRA and another unrelated party is unrealistic and unnecessary to establish actual fair market value.
- 50% Rule is Reduced to a New 10% Rule: Changes the 50% rule that states a company is a disqualified person to an IRA when it is owned 50% or more by disqualified persons (e.g. IRA owner and certain family). The new rule makes a company disqualified when owned 10% or more by disqualified persons.
- Roth IRAs Capped at $5M: Roth IRAs will be capped at $5M. Any amount over $5M must be distributed from the Roth IRA.
- Eliminate Roth Conversions: Traditional IRA funds cannot be converted to Roth IRA funds. Roth IRAs will be allowed only if the account owner makes initial Roth IRA contributions and only when they meet the Roth IRA contribution limits, which restricts high-income earners.
- Require RMD for Roth IRAs: Roth IRAs are currently not subject to required minimum distribution (“RMD”) rules because the amounts distributed do not result in tax. This rule will change and RMD will apply to Roth IRAs when the account holder reaches age 70 ½.
These proposals will have drastic impacts on self-directed IRA investors. The valuation requirement is perhaps the most dramatic as it will require valuations before an IRA can buy an asset and before it can sell an asset. Not only will this cause administrative issues and increased costs, but it will undoubtedly replace the ability of an IRA buyer or an IRA seller from transacting their IRA at the price and value they determine to represent the actual current fair market value of their investments.
I have written a detailed analysis of the bill which I plan to share with the Senate Finance Committee and the Joint Committee on Taxation. I welcome your input as a self-directed IRA investor and plan to advocate for common-sense rules that help self-directed investors take control of their retirement. My draft bill analysis can be accessed at the link below. Please send your comments to firstname.lastname@example.org.