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As we mentioned a few weeks back, some Republicans floated the idea of capping 401(k) plan contributions. In fact, the idea was to lower the maximum contribution limit to just $2,400. This would amount to over an 85% cut to what workers under age 50 can currently contribute tax-deferred to 401(k)s. But it would also lead to an increase in revenue for the federal government, according to those in favor.
We now know that President Trump and other GOP lawmakers were against such a change. And we also know that capping 401(k) plan contributions is not a part of the recently-unveiled GOP tax bill. Another potential change that never surfaced was a proposed five-year payout rule for IRA and 401(k) inheritors.
However, retirement plans aren’t unscathed by the reform bill, known as H.R. 1, the Tax Cuts and Jobs Act.
In fact, if the bill were to pass in its current state, Roth recharacterizations would generally no longer be permitted after 2017.
Whether by rollover or transfer, you can convert your Traditional IRA to a Roth. By paying income tax on any untaxed amounts in the Traditional IRA, you can essentially turn it into a Roth.
But what happens if you have second thoughts about the Roth conversion? Or perhaps your tax advisor determines a Roth conversion is really not in your best interest. Currently, you have the ability to “undo” or “reverse” the action.
The IRS recommends you tell your trustee or custodian to transfer the Roth amount into a Traditional IRA, either with that firm or via another trustee or custodian, by the due date of your tax return (including extensions). By doing so, you effectively ignore the Roth contribution and treat it as a Traditional IRA contribution for that year.
However, the Tax Cuts and Jobs Act has Roth recharacterizations in its crosshairs. If it were to pass as it stands, there would no longer be any such takebacks after 2017. The result would be an estimated $500 million in revenue over 10 years.
Some have long suggested that gaming of the system is taking place with Roth conversions. Opponents of recharacterizations say they allow you to take advantage of the tax-free benefits of a Roth IRA if the account experiences gains but convert the account back to a Traditional IRA if it experiences losses. So, the potential revenue generated would be a result of the IRS being able to appropriately collect the taxes of both account types as intended.
There may be other ways that this proposed legislation could affect you. So, we encourage you to discuss any potential changes related to H.R. 1 with your tax professional.
Sometimes, just learning a little more about the different IRA types can prevent an unnecessary recharacterization. You can learn more about each IRA type elsewhere on our website. Also, check out the IRS page comparing Traditional and Roth IRAs.