The Taxpayer Relief Act of 1997, signed
into law on August 5, 1997, changed some retirement plan and individual retirement account (IRA) rules. Here are some of the principal changes.
Retirement - Plan Changes
A repeal of the 15% excise tax on excess distributions and excess accumulations. The 15% excise tax on distributions above $160,000 annually has been repealed retroactive to December 31, 1996. (It previously had been suspended through 1999.) The 15% tax on excess accumulations of participants has also been repealed retroactive to December 31, 1996.
An increase in the cash-out amount for small distributions. The threshold for distributing accounts to participants without their consent has been increased to $5,000 from $3,500. This is effective for plan years beginning after August 5, 1997.
The elimination of the requirements to file Summary Plan Descriptions (SPDs) and Summary of Material Modifications (SMMs) with the Department of Labor. SPDs and SMMs no longer need to be filed with the U.S. Department
of Labor, effective August 5, 1997.
The clarification of circumstances under which plans are not disqualified by accepting rollovers. The act confirms the Internal Revenue Service's (IRS's) position that a plan accepting an invalid roll-over contribution will not be disqualified if, among other things, it verifies that the contribution came from a qualified plan. For purposes of such verification, it is not necessary that the plan making the distribution have an IRS determination letter.
An increase in the prohibited-transaction
tax. The first-tier tax on prohibited transactions has increased to 15% from 10% for transactions occurring after August 5, 1997.
Partners' matching contributions no longer treated as elective deferrals. Matching contributions made for partners and self-employed individuals will be treated the same as matching contributions made for employees, instead of being treated as elective deferrals. This is effective for years beginning after December 31, 1997, for 401(k) plans and for years beginning after December 31, 1996, for SIMPLE plans. This means, among other things, that partners' matching contributions will no longer be subject to the $9,500 limit on elective deferrals.
New basis-recovery rules. Effective for annuities payable after August 5, 1997, the act provides a new table for basis recovery to be used for a participant who made after-tax employee contributions and elects to receive his or her account in the form of a joint and survivor annuity.
The modification of prohibition on assignment or alienation. If a participant has been convicted of a crime against the plan, or has been determined by a court or the government to have committed a fiduciary breach with respect to the plan, the participant's benefit may be reduced by the amount for which the participant is liable in connection with such crime or fiduciary breach, under certain circumstances. This is effective for judgements, orders and decrees issued and settlements entered into on or after August 5, 1997.
Individual Retirement Account (IRA) Changes
New Roth IRA. Starting in 1998, individuals can contribute up to $2,000 of compensation, and married couples can contribute up to a total of $4,000 ($2,000 per spouse) to a Roth Individual Retirement Account on a nondeductible basis. Although the contributions are nondeductible, earnings accumulate tax-free as long as no distribution is made before the IRA has been held for five years, and each distribution occurs after age 591/2, or death, or total and permanent disability, or to satisfy first-time house-buyer expenses up to a lifetime amount of $10,000. Eligibility for Roth IRA accounts is phased out for single taxpayers with a modified adjusted gross income (MAGI) between $95,000 and $110,000, and for couples with a MAGI between $150,000 and $160,000.
Traditional IRAs. The level of income at which the maximum deduction for IRA contributions begins to be phased out is increased for individuals who are active participants in an employer-sponsored retirement plan. Starting in 1998, the maximum-deduction phaseout range will be $30,000 to $40,000 of MAGI for single taxpayers and $50,000 to $60,000 of MAGI for married taxpayers. Annual increases will be made thereafter until the years 2005 and 2007, respectively. Furthermore, a married individual won't be considered an active participant in a company retirement plan merely because his or her spouse is an active participant. Such an individual can contribute $2,000 of compensation annually. This exception is phased out for joint incomes between $150,000 and $160,000 of MAGI and is effective in 1998.
Penalty-free withdrawals from IRAs. The 10% penalty on premature distributions from IRAs (generally distributions prior to age 591/2) will not apply to distributions made after December 31, 1997, to pay certain postsecondary-school education expenses or first-time house-buyer expenses.
Education IRAs. Taxpayers may contribute up to $500 per child per year to a new education IRA, starting in 1998. Contributions are nondeductible, but earnings accumulate tax free, provided that the amount distributed in any year is not greater than the child's qualifying postsecondary-school education expenses. Eligibility for education IRAs phases out between $95,000 and $110,000 of MAGI for single individuals, and between $150,000 and $160,000 of MAGI for couples.
The most dramatic changes in the new legislation relate to IRAs. The changes relating to 401(k) plans and other qualified plans and 403(b) plans are less significant than those made in 1996 by the Small Business Protection Act.
The contents of this article are intended as general information to alert readers to new developments. They do not constitute legal advice or a legal opinion on any specific facts or circumstances. Neither Merrill Lynch nor any of its employees can provide legal advice. Please consult your attorney regarding legal issues raised in this article.