Tax and financial advice from the Silicon Valley expert.

IRS explains some CARES Act retirement plan provisions

The IRS has posted Frequently Asked Questions relating to CARES Act Retirement Plan Provisions.

According to Q & A 7, a taxpayer who elects to repay a COVID-19 related distribution would pay the tax on the three-year schedule and then amend the tax returns and request refunds when the distribution is repaid.

According to Q & A 9, employers may optionally amend their retirement plans to permit loans and distributions permitted under the CARES Act, so some employers might not allow the increased loans and distributions.

Here is a URL for the FAQs.  https://www.irs.gov/newsroom/coronavirus-related-relief-for-retirement-plans-and-iras-questions-and-answers

Urgent news if you have a retirement account with a Conduit Trust named beneficiary

Legislation called the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, enacted December 20, 2019, renders any estate plan involving a Conduit Trust beneficiary of a big retirement account (including 401(k) accounts and IRAs) obsolete.

A provision of the Act repeals “stretch” payments over the life expectancy of most successor beneficiaries for inherited retirement accounts of decedents who die after December 31, 2019.  The maximum time for distributions is 10 years after the death of the decedent/plan participant.

What is a Conduit Trust?  The purpose of a Conduit Trust was to control a retirement account, usually with a minor beneficiary, and still qualify for distribution of the account over the beneficiary’s life expectancy, called stretch distributions.  In order to qualify, the account had to be disregarded for income tax reporting with respect to the retirement account distributions.  The way this was accomplished was to require that any retirement account distributions received by the trust be immediately distributed to the beneficiary.

Since life expectancy distributions are usually very small, a huge distribution would be payable to the beneficiary 10 years after the death of the account owner, probably subject to very high federal income tax rates and possibly subject to mismanagement by the beneficiary.

There are some exceptions to the new rule, including (1) the surviving spouse of the employee/participant, (2) a child who is under age 21, (3) certain disabled persons, (4) certain chronically ill persons, and (4) an individual not previously described who is not more than 10 years younger than the employee/participant.

When a child of the decedent reaches age 21, the balance of the account must be distributed within 10 years.

If a beneficiary of a retirement account inherited from a person deceased before 2020 is deceased after 2019, the 10 year limit applies to that person’s successor beneficiaries.

Since the Conduit Trust no longer provides a tax benefit, employees/participants with retirement accounts should consult with their attorney and tax consultant about eliminating the Conduit Trust as a beneficiary and making alternative estate plans for their retirement accounts.

Major federal retirement changes enacted, Kiddie tax change repealed

As part of the domestic spending bill, H.R. 1865, Further Consolidated Appropriations Act, 2020, enacted on December 20, 2019, major federal retirement changes were enacted in Division O, the Setting Every Community Up for Retirement Enhancement Act of 2019, nicknamed the SECURE Act.  As part of the SECURE Act, Congress also repealed changes to the Kiddie tax enacted in the Tax Cuts and Jobs Act of 2017.  Taxpayers may elect to amend their 2017 and 2018 individual income tax returns to use this Kiddie tax change.

Here are highlights.  Please consult with your retirement plan consultant or tax consultant for more details.

  • Effective for plan years beginning after December 31, 2020, the rules for multiple employer plans have been relaxed so that if one employer violates the qualification rules, the entire plan won’t be disqualified.  (The “one bad apple rule.”)
  • Effective for plan years beginning after December 31, 2019, the maximum default contribution for a plan with automatic enrollment is increased from 10% to 15%.
  • Effective for taxable years beginning after December 31, 2019, the tax credit for retirement plan startup cost for small employers is increased from the lesser of (1) $500 or (2) 50% of qualified startup costs to the greater of (1) $500 or (2) the lesser of (a) $250 times the number of nonhighly compensated employees of the employer who are eligible to participate in the plan or (b) $5,000.  The credit applies for the first three years of the adoption of the plan.  It’s also available for employers that convert an existing plan to an automatic enrollment design.
  • Effective for taxable years beginning after December 31, 2019, amounts includable in an individual’s income paid to aid the individual in pursuing graduate or postdoctoral study, such as a fellowship, stipend, or similar amount, is treated as compensation for the limitation on IRA contributions.
  • Effective for taxable years beginning after December 31, 2019, the prohibition of contributions to an IRA by an individual who has reached age 70 ½ has been repealed.  The excludable amount for direct distributions to a charity after age 70 ½ is reduced by any contributions to an IRA after age 70 ½.
  • Effective for plan loans made after December 20, 2019, amounts loaned from a plan using a credit card or similar arrangement will be treated as deemed plan distributions and not as loans.
  • Effective for plan years beginning after December 31, 2019, when a plan will no longer accept a lifetime income option, such as an annuity, as a plan investment, employees will be able to make direct transfers of the lifetime income investment to an IRA or another retirement account within the 90-day period ending on the date when the lifetime income investment is no longer accepted by the plan.
  • Effective for plan years beginning after December 31, 2020, employers are required to permit employees to make elective deferrals if the employee has worked at least 500 hours per year with the employer for three consecutive years and has met the age requirement (age 21) by the end of the three-year period.  Each 12-month period for which the employee has at least 500 hours of service shall be treated as a year of service for vesting purposes.  This (500 hour) requirement will not apply for collectively-bargained plans.   Employers may elect to exclude these employees for the nondiscrimination and top-heavy requirements.  Employer contributions won’t be required for these individuals.
  • Effective for distributions made after December 31, 2019, distributions of up to $5,000 per birth or adoption can be made free of the 10% early distributions penalty during the one-year period beginning on the date on which a child of the individual is born or on which the legal adoption by the individual of an eligible adoptee is finalized.  (An eligible adoptee is any individual, other than a child of the taxpayer’s spouse, who has not reached age 18 or is physically or mentally incapable of self-support.)  Taxpayers must include the name, age, and taxpayer identification number of the child or adoptee on their tax return.  The distributions may be recontributed to an individuals eligible retirement plan, subject to certain requirements.
  • Effective for distributions after December 31, 2019, the age at which distributions are required to be made from an IRA or a qualified plan is increased from age 70 1/2 to age 72.  The age at which qualified charitable distributions of up to $100,000 per year from an IRA is unchanged at 70 1/2.
  • Retroactively effective for plan years beginning after December 31, 2017, the actuarial rules for defined benefit plans of privately-owned community newspapers are relaxed.  This is targeted relief benefiting this group.
  • Retroactively effective for defined contribution plan years beginning after December 31, 2015 and effective for IRA contributions after December 20, 2019 , difficulty of care payments that are excludable from gross income are treated as compensation for nondeductible IRA contribution limits.  These are payments by (1) a state or political subdivision of a state, or (2) a qualified foster care placement agency as compensation for providing additional care needed for qualified foster individuals.  The payments are provided when a qualified foster individual has a physical, mental or emotional disability for which the state has determined (1) there is a need for additional compensation to care for the individual; (2) The care is provided in the home of the foster care provider; and (3) the payments are designated by the payor as compensation for that purpose.
  • Effective for taxable years beginning after December 31, 2019, an employer may adopt a qualified retirement plan up to the extended due date of the employer’s federal income tax return and the plan can be retroactively effective for the taxable year.  Although employee contributions can’t be made after the year-end, employer contributions can be made up to the extended due date of the income tax return.  (This rule currently applies to SEP accounts.)
  • Effective for plan years beginning after December 31, 2021, the IRS is to issue procedures for employers who have similar individual account or defined contribution accounts to elect to file combined annual reports (Form 5500.)
  • The IRS is to issue model disclosures showing the estimated lifetime income based on the account balance of a plan participant, to be reported at least annually.  The IRS is also required to provide guidelines for how the income amount should be computed.
  • A fiduciary safe harbor is adopted so plan fiduciaries will satisfy the prudence requirement when selecting an insurer for a guaranteed retirement income (annuity) contract and will be protected from liability for losses that result to to participant or beneficiary due to an insurer’s inability to satisfy its financial obligations under the contract.  (A favorable provision for insurers, not so great for participants and beneficiaries.)
  • Effective on December 20, 2019, and electively retroactive to plan years beginning after December 31, 2013, the nondiscrimination rules are modified to protect older, longer service participation.  These rules are complex and beyond the scope of this explanation.  The rules will allow a closed or frozen plan to continue in existence.
  • Effective for distributions made after December 31, 2018, from Section 529 (educational savings) plans, registered apprenticeship expenses will be considered “qualified higher education expenses.”  Expenses for fees, books, supplies and equipment required for the designated beneficiary to participate in a registered apprenticeship program are qualified expenses for distributions from such a plan.
  • Effective for distributions made after December 31, 2018, up to $10,000 of qualified education loan repayments will be considered “qualified higher education expenses” for distributions from a Section 529 plan.  Student loan interest paid using distributions from a Section 529 plan won’t otherwise qualify for a tax deduction.
  • Effective for distributions made with respect to employees or plan participants who die after December 31, 2019, inherited retirement accounts must generally be distributed within 10 years after the employee or participant’s death.  There is an exception permitting “stretch” distributions based on life expectancy to (1) the surviving spouse of the employee/participant, (2) a child of the employee/participant who hasn’t reached majority, (3) certain disabled beneficiaries, (4) chronically ill beneficiaries, or (4) other beneficiaries who are not more than 10 years younger than the employee.  Once a child of the employee/participant reaches majority, the balance of the account must be distributed within 10 years after the date majority is reached.

The effective date for collective bargaining agreements and government plans will generally be for distributions with respect to employees or plan participants who die after December 31, 2021.

There is an exception for certain existing annuity contracts.

The ten-year distribution requirement also applies to successor beneficiaries of beneficiaries who inherited accounts before December 20, 2019.  (If an employee/participant was deceased during 2019, a surviving spouse might decide to disclaim IRA survivor benefits so that successor beneficiaries will be able to claim “stretch” distributions of benefits for which the election would otherwise be lost.)

Commenters have suggested  designating a charitable remainder trust as a beneficiary of a retirement account as a way to avoid the 10-year limit.  The plan distribution to the trust isn’t subject to current taxation.  Distributions are required to be made annually to the beneficiary(ies) of the CRT, which will probably carry taxable income.  Depending on how long the beneficiary(ies) live, some or all of the balance could go to a charity.  Seek tax and legal counsel when considering this alternative.

  • A provision of the Tax Cuts and Jobs Act of 2017 changed the Kiddie Tax that apples to the unearned income of certain individuals.  The rule applies to a child who (1) is required to file a tax return; (2) does not file a joint income tax return for the tax year; (3) the child’s investment income exceeds a threshold ($2,200 for 2019); (4) either of the child’s parents are alive at the end of the year; and (5) At the end of the tax year, the child is either (a) under age 18; (b) under age 19 and doesn’t provide more than half of his or her own support with earned income; or (c) under age 24, a full-time student, and does not provide more than half of his or her own support with earned income.  Under the Tax Cuts and Jobs Act, the child’s income tax is computed using the tax rate schedule that applies to estates and trusts.  This provision was causing a hardship, especially for survivors of military casualties.   Under the SECURE Act, this change is repealed, effective for tax years beginning after December 31, 2019.  Taxpayers may elect to retroactively apply the change for tax years 2018 and 2019.   This means children will generally be taxed on their unearned income at their parent’s marginal tax rate.  For 2019, the 37% marginal tax rate applies for single persons with taxable income over $510,300 and for estates and trusts with taxable income over $12,750.

IRS proposed regulations will keep more in retirement accounts

The IRS has issued proposed regulations relating to required minimum distributions from retirement accounts, including, 401(k), IRA and Roth IRA accounts.  (Proposed Regulations REG-132210-18, Proposed Regulations Section 1.401(a)(9)-9.)

The required minimum distribution is generally computed using a life expectancy table issued by the IRS, called the lifetime distribution table.  The life expectancy tables haven’t been updated for many years.  The proposed regulations include new life expectancy tables.

(If a taxpayer fails to take a required minimum distribution, the federal penalty is 50% of the undistributed amount.)

Since life expectancies have been increasing, required minimum distributions will be smaller using the proposed tables, potentially leaving larger balances to accumulate future earnings.  Bigger distributions can optionally be taken at the risk of exhausting the account before the employee or plan owner’s death.

The proposed regulations are proposed to be effective for retirement plan distributions for tax years beginning on or after January 1, 2021, provided they are adopted as final regulations by that date.

Required minimum distributions for a non-spouse beneficiary of a deceased employee or a deceased plan owner are based on the life expectancy determined using the Single Life Table of the beneficiary as of the date of death of the employee or plan owner, minus one for each subsequent year.  Under the proposed regulations, the beneficiary will be able to recompute his or her life expectancy as of the date of death of the employee or deceased plan owner using the new lifetime distribution table starting January 1, 2021.

 

Tax and financial advice from the Silicon Valley expert.