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Senate Tax Reform Proposal Caps Catch-Ups

The Chairman’s Mark  of the Senate tax reform proposal throws a few unexpected curves – bringing back problems for deferred compensation plans, introducing some new problems for 403(b) and 457 plans and capping catch-up contributions.

Under the proposal unveiled Nov. 9 by Sen. Orrin Hatch (R-UT), Chairman of the Senate Finance Committee, as of plan years and taxable years beginning after Dec. 31, 2017, individuals could not make any catch-up contributions – even on an after-tax basis – for a year if they received wages of $500,000 or more in the preceding year.

“Capping the ability to make catch-up contributions undermines the incentives of business owners to adopt and support retirement plans,” warned Brian Graff, CEO of the American Retirement Association. “It’s a dangerous precedent – after all, what’s to stop lawmakers from deciding to impose a limit of $250,000 or $125,000?”

Current nondiscrimination rules already serve to maintain a relative parity between more highly compensated workers and other participants. However, as is generally the case with tax reform, the likely goal is raising revenue – though the provision is estimated to raise only about $500 million over 10 years.

Deferred Comp Killer?

The Chairman’s Mark also resurrected the provision that dramatically limited nonqualified deferred compensation which had been in the original proposal introduced in the House – before it was removed from the version approved by the House Ways & Means Committee.

403(b)s and 457s

As for 403(b) and 457(b) plans, the proposal applies a single aggregate limit to contributions for an employee in a governmental Section 457(b) plan and elective deferrals for the same employee under a 401(k) or 403(b) plan of the same employer. It also repeals the special rules allowing additional elective deferrals and catch-up contributions under 403(b) plans and governmental 457(b) plans, so that the same limits will apply to elective deferrals and catch-up contributions under 401(k), 403(b) and governmental 457(b) plans.

Moreover, the proposal repeals the special rule allowing employer contributions to 403(b) plans for up to five years after termination of employment, and revises application of the limit on aggregate contributions to a qualified defined contribution plan or a 403(b) plan (that is, the lesser of either $54,000 (for 2017) or the employee’s compensation). “As revised, a single aggregate limit applies to contributions for an employee to any defined contribution plans, any section 403(b) plans, and any governmental section 457(b) plans maintained by the same employer, including any members of a controlled group or affiliated service group,” according to the Chairman’s Mark. The proposal is effective for plan years and taxable years beginning after Dec. 31, 2017.

Also effective for taxable years beginning after Dec. 31, 2017, unless an exception applies, the early withdrawal tax applies to a distribution from a governmental Section 457(b) plan before age 59½ to the extent the distribution is includible in income.

It is, as we continue to report, early in the process – but, as yesterday’s developments remind us, this is not a time to relax or be complacent. As always, we’ll continue to keep you apprised.