IRS Issues Guidance on Roth 401(k) Rollovers
By Ken Berry, Correspondent
The Roth 401(k), a hybrid of a Roth IRA and a traditional 401(k), has failed to gain much traction in the workplace. But a provision in the American Taxpayer Relief Act of 2012 (ATRA) was designed to grease the skids. Now the IRS has provided valuable guidance on in-plan Roth 401(k) rollovers (Notice 2013-74).
Here's the basic lay of the land. With a Roth IRA, qualified distributions made at least five years after the Roth was established are 100 percent exempt from federal income tax. For this purpose, qualified distributions include those made after attaining age 59½; upon death or disability; or use for a first-time home purchase (up to a lifetime limit of $10,000). A Roth 401(k) is essentially a Roth IRA account set up to hold funds in an employee's 401(k) plan.
Under ATRA, an employee participating in a 401(k) can elect to have the plan transfer any amount "not otherwise distributable" under the plan to a designated Roth account maintained for his or her benefit. In other words, the employee can roll over funds without paying the 10 percent tax penalty for pre-age 59½ distributions, although the transfer is still subject to regular income tax.
The new IRS Notice clarifies the rules for in-plan rollovers. Some of the main points of interest to practitioners are as follows:
- Rollovers to a designated Roth account in the same plan are available for elective deferrals in 401(k) and 403(b) plans; matching contributions and nonelective contributions, including qualified matching contributions and qualified nonelective contributions; and annual deferrals made to governmental 457 plans.
- Amounts rolled over to an employee's designated Roth account are subject to distribution restrictions applicable to the amount before the in-plan Roth rollover. For example, distributions may not be allowed prior to age 59½.
- There's no income tax withholding requirement for a rollover of an otherwise non-distributable amount. However, an employee making an in-plan Roth rollover may have to increase withholding or make estimated tax payments to avoid an underpayment penalty.
- A plan amendment providing for in-plan Roth rollovers of otherwise nondistributable amounts is a discretionary amendment that can't be adopted after the last day of the first plan year in which the amendment is effective. However, to give employers more time to implement this for the 2013 plan year, the IRS is extending the deadline to the later of the last day of the first plan year in which the amendment is effective or December 31, 2014, as long as the amendment is effective as of the date the plan first operates in accordance with the amendment.
- The Notice also provides a temporary period during which sponsors of safe harbor plans are permitted to make a midyear change to provide for in-plan Roth rollovers of otherwise nondistributable amounts. The period ends December 31, 2014.
- Subject to the nondiscrimination requirements normally applicable to plan benefits, rights, and features (e.g., the right to make a rollover), a plan may restrict the type of contributions eligible for an in-plan Roth rollover and the frequency of in-plan Roth rollovers.
- If an in-plan Roth rollover is the first contribution made to an employee's designated Roth account, the five-year period of participation required for qualified distributions begins on the first day of the first tax year in which the employee makes the in-plan Roth rollover.
Remember that these are just the highlights. The entire Notice can be found at http://www.irs.gov/pub/irs-drop/n-13-74.pdf.