Retirement Watch Lighthouse Logo
Retirement Watch Lighthouse Logo

New Tax Law Affects Pensions, Charities

Last update on: Nov 06 2017
tax law

In late July, Congress passed the most comprehensive changes in decades to retirement plans and also made it easier to make charitable gifts with retirement accounts.

Most of the law is directed at the old-style defined benefit plans that pay a guaranteed income for life. Congress became concerned that too many employers were not properly funding their plans and were making promises they could not afford to keep. When an employer cannot fulfill its retirement plan promises, the company can declare bankruptcy and transfer the liability to the Pension Benefit Guarantee Corporation. The PBGC is in poor financial condition. The law is supposed to improve the financial stability of many pension plans and the PBGC.

I fear that the law might have the opposite effect. The higher costs and contribution requirements imposed on employers might very well cause even more employers to terminate or freeze their defined benefit plans. The defined benefit pension plan might become a thing of the past very quickly.

There also are provisions that affect other types of retirement plans and that are important to members of Retirement Watch.

More owners of 401(k) accounts are likely to receive investment advice in the future. Many employers have been unwilling to provide advice or arrange for outside firms to provide advice because of the fiduciary liability and the prohibited transaction rules. The new law waives these restrictions under certain circumstances, and the government will issue regulations to flesh out when it is safe for the employer to provide investment advice. The advice may be provided by a computer model if it meets standards in the law. If a computer model is not used, the fees charged by an advisor cannot vary based on the investment choices selected by the participant.

Employers can impose default options that defer a percentage of an employee’s salary into a 401(k) account and that invest the account. Employers have been very conservative about the default options in the past because of liability concerns.

To encourage greater deferral and higher-return investing, the legal liability of employers is limited by the new law. The default option in a plan can be to defer more salary and invest the accounts for higher growth. Employees still will be free to make their own choices. The law affects only the default option for employees who do not make a choice.

A number of provisions from the 2001 tax law that set higher deduction and contribution limits were set to expire after 2010. These include:

  • Higher IRA contributions limits. 
  • Higher “catch-up” contribution limits for those age 50 and over. 
  • Higher contribution limits for 401(k) plans and also for defined benefit plans. 
  • The saver’s tax credit for modest income households. 

These and other provisions that were set to expire are made permanent in the new law.

Plan participants also receive broader rights to invest their accounts in investments other than the employer’s securities. These will reduce the damage in Enron-like situations when people lost their jobs and saw their retirement accounts dwindle because they were required to own company stock.

The charitable giving section of the law makes it easier to make charitable contributions from an IRA or 401(k). Under prior law, it was not worthwhile to make a lifetime contribution from an IRA or 401(k). You first took a distribution from the plan that was included in gross income. Then, you made a contribution to charity and took a charitable contribution deduction. But you had to itemize deductions in order to get a tax benefit. In addition, the reduction in itemized deductions for higher income taxpayers might have eliminated part of your deduction. Taxpayers could end up paying income taxes on money they gave to charity.

Under the new law, a taxable distribution that is taken from an IRA is excluded from gross income if it is a “qualified charitable distribution.” The exclusion is allowed for distributions of up to $100,000 annually.

A qualified charitable distribution is a distribution made directly by the IRA custodian to a public charitable organization or a donor advised fund. In addition, the IRA owner must be at least age 70½ on the date of the distribution. If the distribution is excluded from gross income, it cannot be taken as charitable contribution deduction. There are special rules when the IRA contains nondeductible contributions.

For example, suppose Max Profits has a traditional IRA with a balance of $100,000 that consists solely of deductible contributions and investment earnings. Max directs the entire balance be distributed to a qualified charity. Under the old law, Max would have to include the entire $100,000 in gross income. But under the new law, none of the $100,000 is included in Max’s gross income, and Max does not take a charitable contribution deduction.

This provision is in effect for years after Dec. 31, 2005, and before Jan. 1, 2008. That means it can be used this year by eligible individuals to make charitable contributions from IRAs.

The new law limits deductions for contributions of clothing and household property. A deduction is allowed for clothing or household property only if the item is in good used condition or better. There is an exception if the item is appraised for more than $500.

The IRS may establish regulations that prohibit any deduction for items that have a minimum value, and the committee report accompanying the law explicitly mentions socks and undergarments. Household items are defined to include furniture, furnishings, electronics, appliances, linens, and similar items. Excluded from the definition are food, paintings, antiques, other objects of art, jewelry, gems, and collections.
The limit is effective after the date the law is enacted.

The recordkeeping rules for charitable contributions of money also are tightened. Donors of cash contributions must maintain a bank record or a written record from the donee organization that shows the name of the charity, date, and amount of the contribution. Other records no longer are acceptable. These rules apply to contributions of any amount made after the date the law is enacted.
We’ll have more details of the law in next month’s visit.



Log In

Forgot Password