- Guidance Issued for In-Plan Rollovers to Roth Accounts
- January 14, 2014 | Authors: Jonathan A. Kenter; Adam M. Meehan
- Law Firms: Troutman Sanders LLP - New York Office ; Troutman Sanders LLP - Atlanta Office
Do you remember the 2012 year-end “Fiscal Cliff” deal (a/k/a the “American Taxpayer Relief Act of 2012” or “ATRA”)? Well, a diminutive provision was slipped into the midnight-hour bill that expanded the types of pre-tax retirement account balances that could be rolled over to post-tax Roth accounts in the same plan. On December 11, 2013, the Internal Revenue Service (IRS) issued guidance (Notice 2013-74) relating to these rollovers and their expansion.
Designated Roth contributions are after-tax contributions to a defined contribution plan that carry certain advantages for plan participants. If a Roth account is offered under a plan, participants may contribute funds on a post-tax elective deferral basis in addition to, or instead of, traditional pre-tax elective deferrals, provided that in the aggregate they do not exceed certain deferral limits (e.g., the “402(g) limit” for 401(k) and 403(b) plans) - $17,500 per individual for 2014.1 An individual’s designated Roth contributions and related earnings must be maintained in a separate account under the plan. The distribution of the earnings component of a Roth account will be tax-free provided that the Roth deferrals remain in the plan for at least five years and the participant satisfies one of the following: (i) attaining age 59½, (ii) death or (iii) disability. An individual’s five-year period starts to run on January 1 of the year in which he or she makes the first Roth contribution.
1 Individuals who are age 50 or over at the end of the calendar year can make annual catch-up contributions ($5,500 per individual for 2014) after meeting the elective deferral threshold.
Prior to the ATRA, 401(k), 403(b) and governmental 457(b) plans were able to allow participants the option of transferring money within the plan from a pre-tax account to a Roth account maintained by the same plan so long as the amount to be transferred was otherwise eligible for distribution under the Internal Revenue Code (even if not otherwise distributable under the more restrictive terms of the plan). For more information on the law pre-ATRA, see the Employee Benefits & Executive Compensation group’s alert published on October 8, 2010. Under the ATRA, effective January 1, 2013, Congress expanded the law by allowing for in-plan Roth conversions of defined contribution retirement plan accounts that are not otherwise distributable without any income limitations.
In-Plan Rollovers of Otherwise Nondistributable Amounts
Amounts credited to the following accounts may be eligible for in-plan rollover treatment even if they are considered “otherwise nondistributable amounts”:
- elective deferrals in 401(k) plans and 403(b) plans;
- matching contributions and nonelective contributions (including qualified matching
- contributions and qualified nonelective contributions);
- non-Roth pre-tax rollover accounts; and
- annual deferrals made to governmental 457(b) plans.
Although the participant will be required to pay federal income tax on the rollover, an in-plan rollover of an otherwise nondistributable amount does not require withholding by the plan sponsor. In-plan Roth rollovers of otherwise nondistributable amounts will remain subject to the distribution restrictions that may have been applicable to such amounts prior to the rollover. Therefore, it is important to account for in-plan Roth rollovers of otherwise nondistributable amounts and related earnings separate from Roth rollover amounts, which are distributable.
For plan sponsors who wish to authorize in-plan Roth rollovers described above, the applicable amendment deadline for 401(k) plans and governmental 457(b) plans is the later of the last day of the first plan year for which the amendment is effective or December 31, 2014. The effective date of the amendment must be prior to or on the date the plan first operates in accordance with the amendment. So, if calendar-year plans allowed in-plan Roth rollovers of otherwise nondistributable amounts in 2013, an amendment to the plan must be adopted no later than December 31, 2014. Notably, this guidance also provides a window until December 31, 2014, for 401(k) safe harbor plans to implement a mid-year amendment (generally prohibited under the 401(k) safe harbor rules) to allow in-plan Roth rollovers.
The IRS has not yet determined the remedial amendment period for 403(b) plans. When it does announce a remedial amendment period, plan sponsors of 403(b) plans will have until the last day of that remedial amendment period (or, if later, the last day of the first plan year in which the amendment is effective) to adopt a plan amendment permitting in-plan Roth rollovers of otherwise nondistributable amounts. Troutman Sanders’ Employee Benefits & Executive Compensation group will alert you when this guidance becomes available.
Guidance Related to All In-Plan Roth Rollovers
The Notice also provides a plethora of other information on in-plan Roth rollovers that applies to both otherwise nondistributable amounts as well as distributable amounts that had been authorized pre-ATRA, as summarized below:
In-plan Roth rollovers are not a Code Section 411(d)(6) protected benefit. In-plan Roth rollovers are not protected benefits so they may be discontinued by plan sponsors without providing a grandfather for then-existing account balances.
Five year holding period. If the first contribution to the Roth account is an in-plan Roth rollover, the five-taxable-year period (requirement for tax-free Roth distributions) will begin to run on the first day of the year in which the in-plan rollover is made.
Allowable restrictions. A plan may restrict the types of contributions eligible for in-plan Roth rollovers and the frequency of such rollovers, except to the extent it would violate the nondiscrimination rules generally applicable to plan benefits, rights and features.
Excess Amount Treatment. If a participant makes an in-plan Roth rollover of his or her entire account and it is later determined that all or a portion of that rolled over amount is an “excess deferral,” “excess contribution” or an “excess aggregate contribution,” the plan must distribute the excess amount from the Roth account even if the amount was not an otherwise nondistributable amount at the time of the rollover.
Top Heavy Status. Plans must count in-plan Roth rollovers in determining the present value of accrued benefits for top-heavy testing purposes.
Net Unrealized Appreciation. For purposes of determining special tax rules for net unrealized appreciation, an in-plan Roth rollover is treated as a distribution.