Some may view it as a belated Christmas present, or an attempt at a New Year’s resolution. However one characterizes it, Congress finally completed and passed legislation that at least temporarily averts the so-called “fiscal cliff” facing our government. As this drama was unfolding, most Americans and lawmakers were focused on income tax rates, jobless benefits, payroll tax withholding, and possible cuts to federal entitlement programs. Pending legislation to extend a long roster of expiring tax provisions was not even part of the dialogue, and both lawmakers and Capitol Hill watchers questioned whether all, or any, of those provisions would be extended at any time in the foreseeable future.
But, as if to prove that one can never be too sure of what will happen in Congress, an 11th hour agreement was reached that led both House and Senate to pass—and the president to sign—the American Taxpayer Relief Act of 2012 (ATRA). As it turned out, this legislation will have a direct impact on IRAs, Coverdell Education Savings Accounts, and employer sponsored retirement plans that allow designated Roth account deferrals. The IRA qualified charitable distribution (QCD) option has been extended from its December 31, 2011 (yes 2011!) expiration through the 2012 year just passed, and through the remainder of 2013. It maintains the ability of IRA owners age 70 ½ or older to contribute up to $100,000 tax free to qualifying charities. This popular and bipartisan-supported option was expected by many to someday be resurrected, but just when was certainly in doubt. Coverdell Education Savings accounts (ESAs) were set to revert to pre-2001 contribution limits and other provisions that would have made these accounts much less attractive as a means to save for our children’s education. Thankfully the 2001 enhancements have been made permanent.
The real surprise in ATRA was the provision allowing plan participants to convert any pre-tax amounts in their employer’s 401(k), 403(b) or governmental 457(b) plan to Roth status—via what’s known as an in-plan Roth rollover, or IRR—at any time, if the plan allows Roth deferrals and elects this liberalized provision. This will allow participants to begin accumulating potentially tax-free assets much sooner than under prior law, which required that such pretax-to-Roth conversions take place only after a participant had satisfied a statutory or regulatory distribution trigger for the type of assets in their accounts. For example, 401(k) plan deferrals generally are unavailable for distribution before a participant reaches age 59 ½. As a result, only at age 59 ½, or later, could an IRR of elective deferrals take place. ATRA changes this and permits an IRR at any time, without the participant having a statutory or regulatory distribution trigger.
It’s clear that lawmakers included this provision in ATRA in the belief that the option would prove popular, and perhaps more important, would generate significant federal tax revenues, since the act of converting a pretax balance to Roth status is a taxable event. In fact, $12.2 billion in tax revenue over 10 years was the estimate of the Congressional Budget Office. This revenue was sought as a way to offset the tax revenue cost, or losses, expected of the other provisions of ATRA. This provision is strikingly similar to earlier legislation that allowed the tax impact of 2010 Roth IRA conversions to be split over 2011 and 2012 tax years, and ultimately raised significant tax revenues in the process.
It’s almost a certainty that we will see more legislation in 2013 that will have an impact on retirement arrangements. Aiding the victims of Hurricane Sandy is almost a certainty, with liberalized access to retirement assets a possible result. There is also the possibility of very fundamental Tax Code restructuring, with consequences we cannot fully predict at this time.
Stay tuned, because in this business it seems that nothing is as constant as change.
