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May 2021

Proposed IRA and Pension Law Changes to be Enacted in 2021

Two Democrats (Mr. Neal and Mr. Brady) have introduced in the House of Representatives a proposed Act which has the title, “Securing a Strong Retirement Act of 2021.” For purposes of this article we will refer to this proposed Act as SECURE II. A similar bill has been introduced in the U.S. Senate. This article discusses the IRA changes set forth in the U.S. House proposal. An article in the June or July issue will discuss the proposed changes for 401(k) and 403(b) plans.

Change #1. Increase in the RMD Age The SECURE Act changed the RMD age from 70 1/2 to 72. Under SECURE II the RMD Age would increase to be age 75 over a number of years as follows:
A. It would be age 72 for any person attaining age 72 in 2022. That is, the person was born in 1950.
B. It would be age 73 for any person attaining age 73 during 2023-2027. That is, the person was born during1951-1955.
C. It would be age 74 for any person attaining age 74 during 2028-2031. That is, the person was born during 1956-1957.
D. It would be age 75 for any person attaining age 74 after 2031. That is, the person was born in 1958 or later.

Change #2. Index the $1,000 Catch-Up Contribution Limit for traditional and Roth IRAs.
Commencing with tax year 2023 the $1,000 catch-up limit would be adjusted by a COLA. The limit would increase in $100 increments. The base year would be 2016 and not 2021 as under current law. Most likely the limit will change to $1,100 or $1,200 in 2023 because of the inflation COLA.

Change #3. Certain Laws Applying to Qualified Longevity Annuity Contracts (QLAC).
There would be a repeal or an elimination of the premium limit of 25% of the aggregated balance. 100% of a person’s traditional IRA, SEP-IRA or SIMPLE-IRA could be invested in a QLAC.

The change would certainly benefit greatly the insurance industry and lead to many IRA owners self-directing their assets into a QLAC versus bank IRA and mutual fund IRAs. Under a QLAC the RMD rules are suspended for a number of years.

Change #4. The Law Would Define an Inadvertent and Incorrect Payment From 401(k) or Other Pension Plan As Being Eligible to be Directly Rolled Over or Rolled Over Into an IRA.

If a 401(k) or other pension plan makes a mistake and a person is overpaid., there can be many tax problems under existing laws. Has an excess contribution been made to the IRA? Must the pension plan somehow get that overpaid amount returned to the plan?

If the plan makes the decision not to recoup the overpayment, Secure II authorizes that the overpayment is treated as being eligible to be rolled over.

If the plan seeks the repayment, and the individual and the IRA custodian agree to repay the overpayment amount, the repayment is to be treated as a qualifying rollover.

If the plan seeks the repayment and the individual contests the repayment under the plan procedures and the plan notifies the IRA custodian then the IRA custodian must “hold” such overpayment amount until there is a determination whether the claim of an overpayment is correct.

Change #5. Reduce the 50% Tax to 25% and Possibly 10%.
A person who fails to take their RMD by the applicable deadline owes a 50% tax on the excess accumulation (missed RMD). This 50% tax has been in the law since 1975. There have been only a few attempts from 1975-2020 to reduce this 50% tax. The IRS does have the statutory authority to waive this 50% tax. The IRS has no authority to lower the rate of the tax to something less than 50%.

The 50% tax would be reduced to 25% and in some cases to 10%. This would be a radical change. It would apply to 2022 and subsequent years.

The 10% rate will apply to an IRA owner or beneficiary who corrects, during a correction period, the shortfall of distributions which had result in the penalty tax being assessed and submits a return during the correction period.

The correction period begins on the date the 25% tax was imposed on the shortfall and ends on the earlier of: the IRS demands payment on account of the shortfall or the last day of the second year that begins after the tax year for which the tax is owed.

Change #6. Creation of Federal Retirement Savings Lost and Found Will Only Have a Minor Impact on IRA Custodians.
A qualified plan administrator of a plan that is not terminated and is to make a distribution to a non-responsive participant who would be eligible for a direct rollover shall transfer such funds to the Federal Retirement Savings Lost and Founds.

Under current law an employer cannot force most participants to withdraw their account balance on separation from service prior to when the RMD rules apply. A participant has the right to remain in the plan until they would reach normal retirement age. However, current law does allow an employer to require a participant with a balance of less than $5,000 to withdraw their entire account balance. This $5,000 limit would be increased to $6,000. The law requires the plan administrator with respect to those participants with a balance of less that $1,000 to establish a rollover IRA on behalf of such a nonresponsive participant. Under SECURE II such funds would be required to be sent to the Federal Retirement Savings Lost and founds.

Change #7. Current law requires an IRA custodian/trustee or other filer of an IRS reporting form to file such form on magnetic media when the filer is required
to file at least 250 forms. This limit would be reduced to be 50 forms.

This change would apply to returns and reports relating to years beginning after the second December 31 occurring after the enactment of SECURE II.

Change #8, Expansion of the IRS Employee Plans Compliance System to IRAs.
For many years the IRS has had a correction program for qualified plans, 403(b) plans and 457(b) plans. The proposal is now to grant certain correcting relief with respect to IRAs. The U.S. Secretary of the Treasury is to grant relief as it sees fit when there has been an inadvertent failure with respect to the following three situations and others as it would decide.

The first situation is, the IRS may waive the 50 % tax (or 25 % or 10%), but it should provide further guidance and procedures.

The second situation is, the IRS may waive the 60 day requirement where the deadline was missed for reasons beyond the control of the individual.

The third situation is one which has been discussed for a number of years. Sometimes an inheriting beneficiary has been paid an amount from an inherited IRA.and learned that current law does not authorize a rollover contribution by a beneficiary regardless if the beneficiary requested the distribution or the distribution was made unilaterally by the IRA custodian. That is, the inadvertent error occurs by the IRA custodian of the inherited IRA.

The beneficiary would be able to correct this situation by returning the distributed funds to the inherited IRA. The correction is warranted when the beneficiary had reason to believe that the distribution could be rolled over but had received bad information from the inherited IRA custodian.

Change #9. One-Time Election For a Qualified Charitable Distribution To a Split-Interest Entity and Adjust $100,000 Limit by a COLA Adjustment.
SECURE II would expressly authorize a qualifying IRA owner or a beneficiary to make a one-time election to make a QCD to a split interest entity. The IRA custodian must make the distribution directly to the split interest entity. The distribution amount cannot exceed $50,000. The term split interest entity means a charitable annuity remainder trust, a charitable remainder trust or a charitable gift annuity.

The annual $100,000 QCD limit will be adjusted by a COLA commencing with distributions made in the tax years ending after the date of the enactment of the SECURE II. This means it will be effective for 2021 if SECURE II is enacted in 2021 .

Change #10. Creation of a Statute of Limitations for Various IRA Transactions.
This change is long over-due. IRA owners and IRA beneficiaries will find this change very beneficial. The law imposes the following taxes: a 10% additional tax for certain distributions prior to age 591/2; a 50% tax for an excess accumulations and a 6% excise tax for an excess contribution. For example, John Doe mistakenly made an excess Roth IRA contribution in 2000. The error is discovered in 2021. Under current law an excess contribution (plus interest and penalties) would apply for each year from 2000-2020.

The SECURE Act would create a statute of limitations which protects IRA owners and beneficiaries from the excise taxes in certain situations.

A taxpayer generally has the duty to file a tax return for a year if they have a certain amount of income or have to pay an excise penalty tax. There are some individuals who are not required to file an income tax return.

Code section 6501 sets forth in general a three year statute of limitations for reporting tax transactions. This provision will grant relief with respect to IRA transactions involving the excise taxes as long as the person has not made a willful attempt to evade or defeat a proper tax.

Change #11. Repayment Period Changed to 3 Years From 1 Year for the Repayment of a Qualified Birth or Adoption Distribution.
The SECURE Act created a new exception to the 10% additional tax. As written the law authorized an IRA owner to repay this distribution within a one year time period. SECURE II would retroactively replace the 1 year repayment period with a 3 year repayment period. This revised rule applies as if the 3 year period had been set forth in the SECURE Act.
Change #12. Creation of a New Exception to the 10% tax for Withdrawals from IRAs and Other Retirement Plans For Individuals In Case of Domestic Abuse.

The rules for this new exception follow the approach which apply to a birth or adoption distribution. The 10% tax will not apply. The distribution must occur within one year and then the person has three years to repay some or all of it. There can be multiple repayments.

Change #13. Lessening Greatly the Rules For When a Prohibited Transaction Occurs With Respect to IRA Assets.
Under current law when there is a prohibited transaction with respect to an IRA, the entire IRA is deemed to be distributed. Normally, the individual must include the entire fair market value of the IRA in their income. SECURE II would repeal the law requiring the IRA to
cease to exist. The IRA would be allowed to continue. There would be a deemed distribution, but only on the portion of the IRA used or involved in the prohibited transaction.

This change applies to tax years beginning after the enactment of SECURE II.

This change is also long over-due. IRA owners and IRA beneficiaries will find this change very beneficial. It is reasonable that the distribution amount is the
amount used in the prohibited transaction and not the entire IRA account balance.

One wonders if the DOL will support this change or whether it to try to have this proposed change not adopted. Remember the DOL has used the prohibited
transaction rules as its source of authority that the failure to provide required rollover advice may be a prohibited transaction in certain situations.
Changes #14. Designated Roth Accounts Within a SEP-IRA or a SIMPLE-IRA.

An employee would have the right to elect that the employer contributions to be made to a SEP-IRA or SIMPLE -IRA plan could go into a Roth IRA. This change would apply to contributions made for tax year 2022.

This change could allow many individuals who are ineligible to a make an annual Roth IRA contribution , but they could make a Roth SEP or SIMPLE contribution.