How Does the American Taxpayer Relief Act affect Retirement Plans?

Posted by Maria T. Hurd, CPA

Taxpayer Relief Act - 401k Audit

Contrary to the retirement plan industry’s fears, the American Taxpayer Relief Act of 2012 (Act) did not reduce the contribution or compensation limits for retirement plans. Instead, it targeted additional government revenues by relaxing the In-Plan Roth Conversion rules. Additionally, the Act extended the qualified charitable rollover deductions through December 31, 2013.

In-Plan Roth Conversions

Effective January 1, 2013, the Act changed the In-Plan Conversion rules to allow conversions of pre-tax balances in a retirement plan to a qualified Roth account within the same plan, even if a distributable event has not taken place.

Under the old rules, In-Plan Roth Conversions were only permitted for amounts eligible for distribution from the plan. For example, a participant must generally be over 59 1/2 or terminate employment to be able to request a distribution from a plan that does not allow in-service distributions.

In an attempt to generate government revenues, the new rules allow In-Plan Roth Conversions of a participant’s account balance, regardless of whether the participant is eligible to receive a distribution. Roth accounts are appealing to individuals who want tax free distributions at retirement because they expect one or more of the following future events to hold true:

a)     Their account will appreciate in value

b)     Their tax rate will be higher when they retire

c)     They would like to leave their retirement accounts to their heirs

To elect the conversion, participants must first make sure that their employer’s plan offers a Roth option. Such conversions are taxed in the year the funds are converted from pre-tax retirement funds to a qualified Roth account. For that reason, individuals who elect to convert their pre-tax balances must take into account the tax consequences of their decision and have enough assets to pay the tax in the year of the conversion.

More guidance is expected to outline the process by which a plan amendment will allow In-Plan Roth Conversions. Interested plan sponsors will have to amend their plans as soon as the guidance is issued, but they can make a good faith effort to comply with the new legislation prior to executing any plan amendments. Absent any additional extensions granted by the IRS, the deadline to adopt this optional amendment will be the last day of the plan year in which it is effective.

Unlike IRA Charitable Rollovers discussed in the next section, In-Plan Roth Conversion provisions are permanent.

IRA Charitable Rollovers

Through December 31, 2011, individuals who received distributions from IRAs or retirement accounts could choose to donate the amount received to a charity and avoid paying taxes on the distribution while receiving a charitable contribution deduction. The qualified charitable rollover provisions were extended through December 31, 2013, when they are scheduled to expire again.

As discussed in our Belfint Nonprofit Ledger blog titled How Does the American Taxpayer Relief Act Affect Nonprofits, a Required Minimum Distribution (RMD) made in December 2012 that is donated to charity in January 2013 is eligible to be considered as a charitable contribution made on December 31, 2012. Also, January 2013 RMDs transferred directly to charity may be considered as made on December 31, 2012, but this tax treatment is an election, it is not automatic. In most cases, such elections will be made in situations where the taxpayer did not take out the proper amount of RMD in 2012, since the election to have the January distribution treated as a 2012 distribution will cure the shortfall and avoid the imposition of the 50% penalty. As such, eligible and interested individuals need to act quickly to take advantage of the infrequent opportunity to get a double tax benefit by donating their retirement plan distribution to charity.

Individuals interested in the In-Plan Roth Conversion or the qualified Charitable Rollover should consult their accountant and plan administrator to ensure compliance with all the intricate rules of these two provisions.

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