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How the tax bill could change how you save for retirement

  • The Tax Cuts and Jobs Act was unveiled on Thursday, leaving rules on pre-tax contributions to 401(k)s unchanged.
  • Several other proposed changes could affect the way you invest your retirement funds.
House Way and Means Chairman Kevin Brady (L) (R-TX) and Speaker of the House Paul Ryan (R) (R-WI), joined by members of the House Republican leadership, introduce tax reform legislation November 2, 2017 in Washington, DC.
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House Way and Means Chairman Kevin Brady (L) (R-TX) and Speaker of the House Paul Ryan (R) (R-WI), joined by members of the House Republican leadership, introduce tax reform legislation November 2, 2017 in Washington, DC.

Americans may face new rules to how they save for retirement, if a tax bill released by Congress on Thursday goes through.

The Tax Cuts and Jobs Act left pre-tax contribution limits to 401(k) retirement plans alone, but other changes could affect the way savers invest in these and individual retirement accounts.

The bill goes to "markup" next week, so any changes may not stick, said Jennifer Brown, manager of research at the National Institute on Retirement Security, a research organization.

"They could come in and do other things with retirement that would also raise revenue," namely lowering pre-tax contribution limits for 401(k)s, which currently stand at $18,000, and $24,000 for individuals 50 and over, even though President Donald Trump has nixed that idea.

Following are some of the proposed changes that will affect retirement savers.

No more undoing IRA conversions

Currently, savers can undo, or "recharacterize," their Roth, or post tax, individual retirement account contributions to traditional IRAs, or pretax contributions, and vice versa. Savers usually have until Oct. 15 of the year following the conversion to undo the transaction.

But the tax bill includes a repeal of the rule that allows for those transactions.

The change could potentially hurt some investors because it will give them less flexibility, said James Lange, president of Lange Financial Group, which provides services to investors in IRAs and retirement plans.

For example, an investor could make a $30,000 conversion to a Roth IRA. But if the market subsequently fell dramatically and the account dropped to $20,000, the investor would still face a tax bill for the $30,000. Before the change proposed in the tax bill, investors could undo the transaction, according to Lange.

"Now, boom, you have all this additional income and maybe the Roth conversion is pushing you into too high of a tax bracket, and you will not be able to undo it," Lange said.

Relaxed rules following hardship distributions

Under current rules, employees younger than 59½ cannot take distributions on their retirement accounts while they are still working. But there is an exception for when participants face a significant financial need. Rules currently prohibit those individuals from contributing to their plans for six months following the distribution.

The bill proposes changing that so that individuals who take hardship withdrawals can still continue to save during that time.

Hardship withdrawals beyond employee contributions

Current rules only allow savers to take hardship withdrawals on funds that they have invested in their plans, and not on money the account earned or received from the employer.

But the bill proposes changing that so that both earnings and employer contributions could also be included.

"It would enable larger distributions for those in need," said Alison Borland, executive vice president of defined contribution solutions at benefits administrator Alight Solutions.

The changes to the hardship withdrawals are a positive for investors, according to Borland, because existing rules can make a bad financial situation worse for the individuals who are facing them.

Extended time to pay back plan loans

Current rules let savers borrow from their plans. When a loan is outstanding and an employee is either terminated or leaves their job, they currently have just 60 days to repay the balance of the loan. If they don't make that payment, the loan is treated as a taxable distribution.

New changes proposed in the bill would change it so that those workers would have until the due date for their tax return for that year to pay the loan balance.

The change will give individuals more time to pay the loan back, depending on when they cut ties with their job, according to Borland.

Say an employee leaves in March, 2018. They would not have to pay the loan back until their tax bill for that year is due in April, 2019. "That would give you an extra year and a month of flexibility," Borland said.

Changes to protect 'older, longer service' participants

As employers move away from providing pension plans in favor of 401(k)s, that can pose problems for those who are offering both. Employers may have legacy pension plans that are closed to new participants, while offering new employees the opportunity to participate in a 401(k) plan. But that can cause issues with non-discrimination rules, which require that the plans offered do not favor high earners.

The new provision will provide employers with a greater ability to compare those plans in order to make sure they are providing employees with an equal opportunity to save.

The new rule could benefit employees who are 55 and older who have been with a company for a substantial amount of time, by preventing them from getting shut out from participating in their company's pension plan, according to Borland.

"It tends to be employees close to retirement who have worked for a company for a long time who are most likely to be impacted," Borland said.