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June 2022

New Proposed IRA Law Changes

In June of 2022 the Senate Finance Committee approved proposed tax legislation with the title, “Enhancing American Retirement Now (EARN) Act.” The vote in the committee was unanimous. If approved by the entire Senate it will need to be reconciled with the proposed legislation as approved by the House of Representatives.

The following law changes would become law.
1. RMD age will increase to age 75 from age 72.

2. Reduce the 50% Tax. Under the proposed law the tax rate would either be 25% or 10%. The 10% tax rate would apply if the excess accumulation is corrected within two years of the excess accumulation (missed RMD).

3. Index the $1,000 IRA catch-up for Inflation. A person eligible to make an IRA contribution who is age 50 or older is permitted to make an additional $1,000 contribution. This contribution is called a catch-up contribution. Under current law this $1,000 has not been indexed to increase on account of inflation. It would be indexed.

CWF Comment. It is about time the $1,000 limit is indexed since the initial 401(k) catch-up amount of $1,000 has increased to $6,500.

The $6,000 limit was initially indexed to increase at the same rate as other tax limits. A few years ago the law was changed so the $6,000 limit increases at a much slower rate. The $6,000 limit should be adjusted at the same rate the 401(k) limits are adjusted.

4. Additional exceptions to the 10% additional tax. The concept of current law is - a person should not be withdrawing these funds prior to age 59 1/2 because these are retirement funds. But there are now many exceptions when the law permits a person to withdraw the funds and pay tax on the amount withdrawn even though not used for retirement, but the 10% tax is not assessed. The proposal is to create new exceptions for additional worthy causes.

A. An exception for a terminal Illness.

B. An exception for domestic abuse. There would be a limit of $10,000 or 50% of the account balance if the account balance was less than $20,000. Such a withdrawal could be rolled over under special rollover rules.

C. An exception for withdrawing IRA funds to be used to pay an “emergency expense”. An emergency expense is an expenses which is unforeseeable or one which creates an immediate financial need. Special rules would apply. The person would be limited to withdrawing one distribution of $1,000 or less per year. The person would be able to repay the distribution within a 3-year time period.

D. An exception for withdrawing the income related to an excess IRA contribution.

E. A clarification that the waiver of the 10% tax for a distribution which is a substantially equal periodic payment applies when that account is rolled over, there is an exchange of an annuity or the annuity satisfies the RMD rules.

F. An IRA owner would be authorized to withdraw $2500 to pay premiums related to a qualifying long-term care insurance contract and the 10% additional tax will not be owed. The long term contract is one that will provide meaningful financial assistance if the IRA owner need home based assistance or nursing home care.

5. The Saver’s Tax Credit would be changed. This credit is available to individuals who don’t have high incomes. The applicable income limit would be raised to make more persons eligible to claim this credit. Currently there are three qualifying credit rates: 10%, 20% and 50%. The new law would phase out the 50% rate over the various income ranges.

The other main change is - rather than being a credit which is used to lower a person’s tax liability, the credit amount would be required to be deposited into the person’s IRA.

6. A SEP-IRA for nannies and other domestic employees. Under current law most any business in the U.S., may establish a SEP-IRA retirement program. There must be a business. There is no business when a person or a family hires a domestic employee. The law requires that social security taxes are owed on the income paid to a domestic worker. This change would permit the person who has hired the nanny to set-up an SEP-IRA for the nanny.

CWF Comment. This change is not needed. It is designed to give the person doing the hiring an additional benefit so it would be more likely the nanny would go to work for this person. Current law authorizes a nanny as a self-employed person to establish a SEP-IRA

7. An Employer Would be Authorized to Make Additional SIMPLE-IRA Contributions. An employer which presently sponsors a SIMPLE-IRA program is restricted in the amount of contributions which it can make. Most employers like the fact that the amount they are required to contribute is limited. It is the employees who make most of the contributions by making elective deferrals. The employer in general is limited to contributing either 2% of the employees’ compensation or making a matching contribution of 3% of the amount deferred. Some employers would like to make an additional “profit sharing” contribution like is done under a profit sharing plan or a 401(k) profit sharing plan. The proposal would be to allow an employer to make an additional contribution for employees equal to the lesser of $5,000 or 10% of compensation.

8. Increase in the Catch-Up Amount for Certain SIMPLE-IRA Participants Age 60 -63. Current law authorizes a SIMPLE-IRA participant age 50 or older to increase their elective deferral by $3,000. The proposal is to increase this limit to $5,000.

9. Two QCD (Qualified Charitable Distribution) Changes. Current law provides that an IRA owner age 701/2 or older may annually make a QCD to the extent of $100,000. This would be indexed for inflation.

The second change is - the IRA owner rather than being required to have the IRA funds given to a charity would once in their lifetime be able to give $50,000 to charities through charitable gift annuities, charitable remainder unitrusts and charitable remainder annuity trusts.

10. A Major Change in the Disaster Relief Laws. Current law permits a person to withdraw $100,000 on account of a federally declared disaster. This $100,000 limit would be reduced to $22,000.

Three of the current benefits would not be changed - 10% additional tax is not owed, may spread the distribution over 3 years for tax purposes and the person is allowed to repay the amount over 3 years. The laws applying to loans from 401(k) plans would be changed to increase the permissible loan amount on account of a disaster and the repayment period could be longer than 5 years.

11. IRS is instructed it Must Expand EPCRS in two ways. Under current law the IRS permits employer sponsored plans to correct tax qualification situations. In many situations an employer must pay the IRS a fee to retain its tax qualified status.

A. An employer which has made an inadvertent mistake (i.e one which is not an egregious mistake) would be permitted to self-correct it without paying the IRS and fee or penalty. The IRS would need to issue additional guidance.

B. This revised procedure would be expanded to cover various IRA failures.

12. 3-Year Repayment Period to apply to a qualified birth or adoption distribution. The law has a 1-year period for certain distributions which the recipient repays. The SECURE Act did not define a time period when such a distribution was to be repaid. Most people assumed it would the 1-year rule. It will be 3 years under this proposal.

13. QLAC Changes - Good for the Insurance Companies, But Bad for Banks. The insurance industry does a better job lobbying Congress than the banking industry. The proposed QLAC changes support this statement.

The amount in a QLAC is excluded from the RMD calculation until the person reaches age 85. Under current law there is a limit on the amount of premiums to be for the QLAC. The limit for 2022 is $135,000. The person also may not have more than 25% of their retirement plan assets invested in QLAC(s).

The proposal is to allow 100% of a person’s retirement plan assets be invested in QLAC(s) and to increase the limit to $200,000. One would think that the banking industry would be smart enough to understand this change will hurt banks greatly. An IRA owner by moving 100% of their IRA funds into a QLAC can eliminate their RMD requirement until the year one attains age 85.

14. Increase in contribution limit for SIMPLE-IRAs. Current limit is $14,000 if you are under age 50 and $17,000 if you are age 50 or older. New proposed limit is $16,500 if you are under age 50 and $21,250 if you are age 50 or older. The catch-up amount is increased to $4,750 from $3000. However for these higher limits to apply the employer’s match must be 4% of compensation rather than 3%.

15. “Radical” SEP and SIMPLE-IRA Proposed Changes - New Roth-SEP and Roth-SIMPLE Accounts. A participant of a SEP-IRA or a SIMPLE-IRA plan would have right to instruct the employer/plan administrator that their elective deferral was to be treated as a special Roth IRA contribution or their employer’s SEP contribution as special Roth IRA contributions.

This change is considered to raise revenue because the current tax revenues increase because the individual’s taxable income is not decreased because of the SEP-IRA and SIMPLE-IRA contributions. The Senate needs to explain how this change would impact SEP-IRA contributions as the employer presumably expects to be able to a claim a tax deduction for its contribution.

© Copyright Collin W. Fritz and Associates, Ltd. “The Pension Specialists”