How Tax Reform is Impacting Your 401(k) Plan

By Anne Morris

Tax reform is always a hot topic, and the media is quick to jump in and report on what this means to individuals and, sometimes, businesses. However, tax reform can also impact your company’s 401(k) plan.

Some recent changes require you to update two of your processes; one this year and another next. Designed to help your employees, the reform items may not seem as good as they sound when you consider preparedness for retirement over the long-term.

Repayment of Loans Upon Termination Extended
Do you allow employees to take out a loan against their balance in your 401(k) plan? If so, you aren’t alone. While not a requirement, many plans allow loans. And any plan that allows loans has had to help a former employee understand what termination from the company means for that outstanding loan balance. However, the rules have changed.

The Tax Cuts and Jobs Act (TCJA) now provides a break to any participant with an outstanding loan balance. Beginning this year, your former employees now have more time to repay this loan before they face penalty. Here’s the difference: 

  • The Old Way. If an employee has a loan balance, it had to be repaid within 60 days of termination. A contribution of the loan balance could also be made to the new employer’s plan or to an IRA, too. If this was not done, the loan balance was considered a taxable distribution and the employee would pay an early distribution penalty if they were under 59 1/2 years old. 
  • The New Way. A former employee now has until the tax filing deadline to repay the loan balance. This includes any filing extension. As long as it’s repaid by then, there will be no taxes or penalties due. 

 The extra time used to pay back the loan means less time that money is growing and the more dollars lost due to missed market appreciation.

More Funds Available for Hardship Withdrawals
A modification to the Bipartisan Budget Act (BBA) could substantially increase the funds available for withdrawal by participants in case of hardship. While not required, most plans do allow for these types of withdrawals if the employee has first taken a loan from the account.

Under current law, an employee can take out the funds he or she contributed to the account. Next year, the amount expands to include matching contributions, as well as earnings on contributions. The longer the person has been contributing to the plan, the greater the funds available.

While this will help with an immediate need, the participant is sacrificing long-term benefits.

Changes Don’t Help Over the Long Haul
While they sound beneficial, these changes can result in a smaller nest egg come retirement time. At a time when most Americans don’t save enough for retirement, your employees need to understand how taking longer to pay back a loan and taking a larger hardship withdrawal can impact overall retirement savings.

Consider providing education around why they should let their account balance grow undisturbed. Also, include information on the sizable tax consequences that happen as a result. Don’t let these changes hurt your employees. Try to get them to focus on the long-term. It will make a big difference for them come retirement time.

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