By Natalie Choate

How the Tax Cuts and Jobs Act Affects Retirement Benefits

© TheStreet
How the Tax Cuts and Jobs Act Affects Retirement Benefits

The Tax Cuts and Jobs Act of 2017 (TCJA) makes sweeping changes to the tax code, but only a few directly impacting retirement benefits. The biggest change is the elimination of the ability to undo a Roth conversion. Minor changes include an extended rollover deadline for some plan loan distributions, comments blessing “back-door Roth contributions,” special deals for “qualified 2016 disaster distributions,” elimination of the ability to deduct IRA losses or the payback of small plan overpayments, and an indirect boost to qualified charitable distributions.


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Also interesting is what is not included in the law. We still have the life expectancy “stretch” payout and the ability to use recharacterization to fix some IRA mistakes, and we still do not have lifetime RMDs for Roth IRAs.

Undoing Roth Conversions

The most significant change TCJA makes regarding retirement benefits is the elimination of the right to undo, or recharacterize, a Roth IRA conversion.

Since 1998, individuals have had the right to convert all or part of a traditional IRA to a Roth IRA, at the cost of paying income tax currently on the converted amount. There have been lots of changes over the years since 1998: For conversions in some years, the taxable income from a conversion could be spread over several taxable years. Prior to 2010, only individuals with modified adjusted gross income under $100,000 were permitted to convert; now there is no income limitation. For some years, only traditional IRAs could be converted to Roth IRAs; now, a distribution from almost any traditional retirement plan can be transferred (converted) to a Roth IRA. At one time, Roth IRAs were the only possible destination for conversion contributions; in recent years, in-plan conversions (transfer from a traditional plan account to a designated Roth account in the same 401(k) plan) have been allowed (if permitted by the plan).

Throughout the 20-year existence of Roth IRAs, the Roth IRA converter has had a unique privilege: The option to change his or her mind and reverse the conversion, until the extended due date of his or her tax return for the conversion year.

Note that the option to recharacterize a Roth conversion applied only to conversions to Roth IRAs — “in-plan conversions” have never been reversible.

The TCJA eliminates the right to undo a Roth IRA conversion. For Roth IRA conversions in 2018 and later, there will be no option to recharacterize the conversion; all Roth conversions will be irrevocable.

What’s not clear yet is how the TCJA impacts 2017 conversions. Under pre-TCJA law, the 2017 conversion of a traditional plan or IRA to a Roth IRA would have been reversible until Oct. 15, 2018 (assuming the individual timely filed his or her 2017 income tax return). The provision of TCJA disallowing recharacterization for a Roth IRA conversion contribution “shall apply to taxable years beginning after Dec. 31, 2017.” Some practitioners read this to mean that the ban applies to Roth conversions that occur after 2017, meaning that conversions that occurred in tax year 2017 can still be reversed until the Oct. 15, 2018 deadline. Other practitioners read the law as simply banning, after Dec. 31, 2017, the recharacterization of any Roth conversion, regardless of when such conversion occurred.

Under this more pessimistic reading, the TCJA effectively accelerated the recharacterization deadline for 2017 conversions from Oct. 15, 2018 to Dec. 31, 2017. If this reading prevails, it’s a bit rough on 2017 converters who reasonably understood and believed, when they did their conversions, that they had until Oct. 15, 2018, to change their minds. It seems likely that few such 2017 converters could have learned of the accelerated deadline in time to act on it.

If it turns out that the pessimistic reading is correct, is there any way a 2017 converter can recharacterize in 2018? There is a process under IRS regulations, nicknamed “9100 relief,” for obtaining extension of a tax deadline if various (extensive) requirements are met, but the cost of obtaining such relief on an individual basis starts with a $10,000 filing fee and goes on to include legal fees, delay, etc.

The IRS might be able to solve this mess by administrative action, either by adopting the interpretation that the ban on recharacterizing Roth conversions applies only to post-2017 conversions, or perhaps by granting some type of blanket extension or “9100 relief” to 2017 converters. We must wait and see.

Recharacterization to Fix Some IRA Mistakes Still Lives

On the bright side, the TCJA as finally enacted preserves recharacterization as a method for fixing some IRA contribution mistakes.

[Earlier versions of the bill would have thrown out the recharacterization “as-mistake-fixer” baby along with the recharacterization “as-a-way-to-undo-a-Roth-conversion” bath water.]

Under the new tax law as enacted, a contribution to one IRA can still (after 2017) be recharacterized as a contribution to another IRA (just as was true before 2018), except as otherwise limited by the statute or by the IRS. There are two primary limitations on the recharacterization option. One is the new statutory ban on recharacterizing a Roth conversion contribution, discussed above. The other is the IRS’s long-standing regulatory prohibition against recharacterizing any tax-free rollover contribution.

In other words, there is still plenty of room to use recharacterization to fix mistakes.

Here’s an example: in Year 1, Bob retires from Acme. He has a traditional IRA and a Roth IRA at ABC Financial Institution. He directs the plan administrator of his Acme 401(k) plan to transfer his designated Roth account in that plan via direct rollover to his Roth IRA. Because of errors by Acme and/or ABC Financial, the money is deposited in Bob’s traditional IRA. That’s not a valid rollover. It’s not legal to transfer designated Roth account money to a traditional IRA. Because it’s not a valid rollover, if nothing is done, the transaction would be treated as a distribution to Bob from the Acme plan, followed by a “regular” (and excess) contribution to the traditional IRA. How can Bob fix this without incurring those bad results?

Bob needs to recharacterize the contribution that was made to the wrong IRA. Recharacterizing is done by transferring the contribution plus earnings thereon directly from the IRA to which it was contributed, to a different IRA by the extended due date of the individual’s tax return.

Bob directs ABC Financial to transfer, from his traditional IRA to his Roth IRA, the amount incorrectly rolled into the traditional IRA from the Acme plan plus any earnings accrued on that amount while it lived inside the traditional IRA. If this is accomplished by Oct. 15 of Year 2, Bob has made a successful recharacterization of the improper rollover contribution.

When it’s an option, recharacterization, as a way of fixing a mistaken IRA contribution, has three advantages over the more common 60-day rollover. First, in a recharacterization, Bob can (in fact must) transfer the earnings along with the contribution; with a 60-day rollover, only the contribution itself and not the earnings can be rolled into the transferee account. Second, recharacterization is not subject to a 60-day deadline; the deadline is the extended due date of the individual’s income tax return (generally meaning Oct. 15 of the year after the mistake occurred, if the income tax return is timely filed). Third, recharacterization is not subject to the once-per-12-months limitation normally applicable to IRA-to-IRA rollovers.

For full details on recharacterizing IRA contributions, including how to compute “earnings thereon,” download the author’s Special Report: IRA Mistakes and How to Fix Them.

Back-Door Roth IRA Contributions Blessed

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Though not part of the law itself, the Conference Committee’s Explanatory Statement of the TCJA explicitly blesses a popular technique that some had questioned, namely, the back-door Roth contribution. An individual who is under age 70½ and who has compensation income, but whose adjusted gross income is too high to permit her to make an annual-type contribution to a Roth IRA, can instead make her annual contribution to a traditional IRA, then convert that traditional IRA to a Roth (because there is no income limit applicable to conversions).

Some had questioned the legality of such an indirect Roth IRA contribution, saying it might be illegal under the “step transaction doctrine.” The Conference Committee confirms that back-door Roth contributions are legal, under both prior law and the TCJA. The Explanatory Statement states four times that, “Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA….”

Extended Rollover Deadline for Certain Plan Loan Distributions

Under the TCJA, an employee who gets a plan loan gets a new little break: If the plan terminates, or the employee’s employment terminates, the loan typically becomes due immediately in full. If the employee can’t pay it back, the outstanding loan balance is treated as a distribution to him.

He can roll over that distribution to avoid being taxable on it, but until now the rollover deadline was the usual 60 days. Under the TCJA, this particular type of distribution gets a longer rollover deadline, the extended due date of the employee’s tax return for the year of the distribution.

Note that this new grace period applies only when the plan loan repayment date is accelerated due to termination of the plan or of the employee’s employment. The new provision will not help the employee who simply defaults on his regular plan loan repayments. That type of deemed distribution is still not eligible for rollover at all.

Special Deals for Qualified 2016 Disaster Distributions

If a client made one or more retirement plan withdrawals in 2016 or 2017, an adviser might want to determine whether she is eligible for special treatment on any such distribution by virtue of (1) having her principal place of abode located in a declared 2016 disaster area and (2) sustaining an economic loss “by reason” of the applicable disaster. The disaster relief may require amending some 2016 returns.

A new type of retirement plan distribution is created and given various special breaks and deals by the TCJA. The new type of distribution is the “qualified 2016 disaster distribution” (“QDD”). A QDD is defined as follows:

The distribution is made from an “eligible retirement plan” after 2015 and before 2018 (i.e., anytime during 2016 or 2017). Eligible retirement plans are IRAs, qualified retirement plans (QRPs) (such as a 401(k) plan), 403(b) plans and contracts, and governmental 457(b) plans.

The distribution is made to an individual (1) whose principal place of abode at any time during calendar year 2016 was located in a “2016 disaster area” and (2) who has sustained an economic loss by reason of the events giving rise to the presidential declaration applicable to the disaster area.

Note that although QDDs can be made in 2016 or 2017, the disaster itself must have occurred in 2016. Thus, for example, this particular tax relief does not help victims of Hurricanes Harvey and Irma, both of which occurred in 2017.

If an adviser determines their client suffered an economic loss due to a presidentially declared 2016 major disaster, and their “principal place of abode” was located in the official disaster area, and they took one or more withdrawals from his/her retirement plan(s) in 2016 and/or 2017, they qualify for the special treatment for “QDDs.”

Here is what that special treatment is:

$100,000 limit. Regardless of how much money your client withdrew from his/her retirement accounts in 2016-2017, the maximum amount that can be treated as QDD is $100,000. For example, if the client withdrew $150,000 from his IRA, only the first $100,000 of that is treated as a QDD. If the individual received potentially eligible distributions in both 2016 and 2017, the maximum amount available for 2017 is $100,000 minus whatever the individual treated as QDDs in 2016.

10% penalty does not apply. The 10% “additional tax” on distributions taken prior to age 59½ does not apply to a QDD.

Extended rollover period. Rather than the usual 60-day rollover deadline, a QDD can be rolled over at any time within three years after the distribution.

Income averaging for amounts not rolled over. To the extent the QDD is not rolled over, the income it generates is included in gross income ratably over the three taxable years beginning with the year of distribution, unless the taxpayer elects out of this averaging treatment.

Certain other rollover requirements waived? It appears that the intent of TCJA Sec. 11028(b)(1)(C)(ii) and (iii) is, with respect to the would-be rollover of any QDD, to exempt such distribution from some other normal rollover requirements (over and above the 60-day deadline), by treating the rollover of a QDD as “a direct trustee to trustee transfer within 60 days of the distribution.” Thus, the QDD rollover would apparently be exempted from, for example, the once-per-12-months rule normally applicable to IRA-to-IRA rollovers. Practitioners may wish to study these clauses to see whether they overcome other normal rollover restrictions, such as the prohibition against rolling over a hardship distribution or a distribution from an inherited plan.

The TCJA contains various technical and conforming rules designed to make sure plans are not somehow disqualified by making these distributions, and dealing with the requirement of amending the plan, etc. Other TCJA provisions offer potentially increased casualty loss deductions to 2016 disaster victims.

IRA Losses Will Be Non-Deductible

Now for some bad news that (hopefully) affects very few people. If you close out all your IRAs, or all your Roth IRAs, and the net amount thus distributed to you is less than your “basis” in those accounts (i.e., less than the amount of your after-tax contributions to the accounts) (including conversion contributions, in the case of Roth IRAs), the IRS position is that the loss you have thus realized is deductible only under “Expenses for production of income.” As such, the loss is a “miscellaneous itemized deduction,” meaning that (until now) the loss was deductible only to the extent the total of such loss and your other “miscellaneous itemized deductions” exceeded 2% of your adjusted gross income.

Under the TCJA, deductions formerly subject to the 2% floor become completely nondeductible. Effectively, the 2% floor becomes a 100% floor. Thus, such a loss upon cashing out all your IRAs (or Roth IRAs) will not be deductible at all for the years 2018-2025.

Payback of Small Plan Overpayment

Suppose you retire and your company’s retirement plan says congratulations, you’re entitled to $10,000 under the plan. Here’s your check. You take the money, cash the check, and have some fun with the money. Of course, the distribution is included your income, so you pay tax on it.

Some years later it turns out the company goofed. They paid you someone else’s money. It turns out there were two employees with the same name. How were they supposed to know? Bottom line: You were entitled to only $7,000. You owe the plan $3,000. You pay back the $3,000. It seems like you should get a tax deduction for that, right? After all, you did include it in income back when you received it.

According to the IRS, repayment of an overpayment of this type, if $3,000 or less, is an “employee business expense.” Employee business expenses are “miscellaneous itemized deductions,” subject (pre-2018) to the 2% floor and (post-2017) totally nondeductible under TCJA. Thus, you have the obligation to pay income tax on the $10,000 distribution when you get it, but when you are forced to repay part of it in a different tax year, if the overpayment was $3,000 or less, you get no tax deduction.

If you are lucky enough that the overpayment was over $3,000, then you can deduct your repayment in full, because then your payment comes under the “claim of right” rule. A claim of right deduction is not subject to the old 2% floor rule and therefore remains fully deductible even under TCJA.

Indirect Impact on QCDs

TCJA may make qualified charitable distributions (QCDs) even more popular than they already are. An individual over age 70½ can transfer up to $100,000 per year from his IRA directly to most types of charities. This device allows the IRA owner to satisfy his charitable giving and his RMD without having either the income or the deduction appear on his tax return. That effect has always meant that some individuals could use the standard deduction on their income tax return, while also getting the benefit of the “charitable deduction” by virtue of excluding the QCD from income altogether. Presumably more people will take advantage of that effect now that TCJA has substantially increased the standard deduction (and slashed other deductions).

What’s Not in the New Tax Law…

The TCJA does not eliminate the life expectancy payout method for retirement plan death benefits, nor does it impose lifetime RMD requirements on Roth IRAs. We’ve heard for years now that everyone in Washington supported both these changes, but there is no such provision in the TCJA. For now, the stretch IRA is alive and well, and Roth IRA owners do not have to take any lifetime distributions from their Roth IRAs.

Reprinted with permission from Leimberg Information Services This article originally appeared in LISI Employee Benefits and Retirement Planning Newsletter #685.

About the author: Natalie B. Choate is a lawyer with Nutter McClennen & Fish LLP in Boston, and is the author of the Estate Planner’s Bible on Estate and Distribution planning for IRAs and Other Retirement Plans, Life and Death Planning for Retirement Benefits (7th ed. 2011). The book is available in printed book form at, or in an electronic edition via subscription at Retirement Natalie gratefully acknowledges the editorial assistance of Michael J. Jones, CPA, a partner in Monterey, Calif.’s Thompson Jones LLP.

This article was originally published by TheStreet.

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