Plan Sponsors

The American Taxpayer Relief Act of 2012

   How averting the fiscal cliff affects you as a plan sponsor

January 4, 2013

The late-brokered deal to address the fiscal cliff, signed into law earlier this week, averted some of the fiscal shock that many economists had predicted would be enough to reverse the country’s slow recovery and threaten another recession. The greatest impact of the new law is on individual taxpayers, although there are a few provisions that may affect the retirement plans of plan sponsors. As widely reported, the new law sidesteps other significant issues, including the looming national debt ceiling, more comprehensive tax reform, spending cuts and entitlement reforms.

Here is TIAA’s assessment of the new law as it applies to you as a plan sponsor and also what you can expect in the months ahead:

  • Tax withholding: A number of the law’s provisions affecting tax rates will require administrative adjustments to withholding and reporting for employees. In addition, the law permanently phases out personal exemptions and limits itemized deductions for single taxpayers with adjusted gross income (AGI) of more than $250,000 and joint filers with AGI above $300,000. It also restores immediately the Social Security payroll tax rate, which had been at 4.2% for taxpayers for the last two years, to 6.2% on income up to $113,700. Further, the 3.8% Medicare tax on net investment income enacted under the healthcare law was not repealed and will take effect this year. It applies to single taxpayers with AGI above $200,000 and joint filers with AGI above $250,000.
  • In-plan Roth conversions: In one of the unexpected additions of the new law, a plan may permit all participants to convert their existing pre-tax account balances in 401(k), 403(b) and 457(b) retirement plans to an after-tax Roth account. Until now, such conversions required a “triggering event” (i.e., separation from service, retirement or reaching age 59½). The new law has removed that requirement. This rule took effect January 1, and while many would argue it is an enhancement to current retirement policy, it was primarily enacted to help generate additional federal revenue since such conversions will be a taxable event. This revenue is intended to help pay for the two-month delay in automatic spending cuts (the “sequester”) that’s also part of the new law. Note that as a plan sponsor, you are not required to adopt this new provision and still have the discretion about whether to make this part of your plan. If you do decide to offer your employees this option, it will require a plan amendment. If you already have a Roth provision in your plan, you should expect some pressure to adopt this relaxed rule allowing transfers without a triggering event. If you don’t have a Roth option in your plan, you may get pressure to add it. If you lack the Roth option and want to put one in place, please contact your TIAA Relationship Manager. The Treasury Department and the IRS are expected to issue technical guidance about these Roth conversions. This new provision will require some operational changes within TIAA, which we are currently evaluating. We’ll keep you abreast of further developments.

Looking ahead on taxes
While the fiscal cliff deal effectively prevented the majority of Americans from experiencing substantial tax increases, Congress still has a number of additional issues to address in the coming months. Before the end of February, lawmakers will have to consider increasing the federal debt limit and come up with a plan to avoid the automatic budget cuts specified in the “sequester” that were supposed to go into effect on January 2, 2012, but were delayed by only two months as part of the deal. Additionally, the temporary spending measure under which the government is operating is set to expire at the end of March and will need to be addressed. These events, coupled with the overall desire to reduce the deficit, will drive Congress to consider reforms to the tax code to find more revenue and, potentially, simplify the code for taxpayers.

Expect more debate on tax code deductions. These taxpayer deductions cost the government more than $1 trillion in unrealized revenue each year and include provisions for such deductions as employer healthcare premiums, mortgage interest, and the deferred treatment of retirement plan contributions. Given that Congress will be taking an “everything’s-on-the-table” approach with respect to deficit reduction, these deductions along with many others likely will be scrutinized for the potential revenue they could generate for the federal government.

How the new law affects your employees
There’s been considerable media coverage regarding the impact of the new law on individuals. We’ve provided ongoing updates on our perspective through our website and will continue to offer commentary as the national debate on spending cuts unfolds.

We have experienced a substantial spike in call volume to our call centers. Some of that simply reflects the time of the year but some relates to the situation in Washington. If you also receive more inquiries from your employees about financial implications of the new law on them, feel free to direct them to our website, where they’ll find a lot of information, or to our call centers, which stand ready to serve them. Many market observers forecast that volatility will likely continue, which can further raise anxiety levels. Again, we offer a number of resources to help your employees deal with these complex financial times.

In short, we continue to stand ready to help you in any way we can. We also will keep you abreast of our perspectives on these evolving issues as events play out in the coming weeks and months through our plan sponsor website.