New Guidance Issued on the Expansion of In-Plan Roth Rollovers

On December 11, 2013, the IRS released Notice 2013-74 (the “Notice”), providing guidance on the recent expansion of the types of contributions eligible for an in-plan Roth rollover under new Section 402(c)(4)(E) of the Internal Revenue Code (the “Code”), as added by the American Taxpayer Relief Act of 2012. Before, plans could only allow participants to convert amounts in their plan accounts that otherwise would be eligible for distribution (and qualified as an eligible rollover distribution) into Roth contributions. The addition of a new subsection (c)(4) to Section 402A of the Code now allows plans to permit participants to elect an in-plan Roth rollover of contributions that otherwise would not be eligible for distribution, such as elective deferrals or matching contributions prior to the date a participant severs employment and/or attains age 59½. Because of the significant benefits of the Roth 401(k), the ability to convert any account balance into a Roth account is a valuable retirement planning tool. If you are interested in a comprehensive summary of the benefits of the Roth 401(k) and what to consider when contemplating whether to add this plan feature, see our prior article The Book on the Roth 401(k) and 403(b) and Why Your Business or Organization Must Have One (Maybe).

Types of Contributions Eligible for In-Plan Roth Conversion Have Expanded

The Notice provides that a plan with designated Roth accounts can now permit in-plan Roth rollovers of all vested amounts. For example, the following contributions (and applicable earnings) could now be rolled over to a designated Roth account, without regard to whether the amounts would otherwise be eligible for distribution:

  • Elective deferrals to 401(k) and 403(b) plans
  • Matching contributions and nonelective contributions (including qualified matching contributions and qualified nonelective contributions)
  • Annual deferrals made to governmental 457(b) plans

However, the amounts rolled over, and applicable earnings, will remain subject to the distribution restrictions that applied before the in-plan Roth rollover. For example, if a 401(k) participant who had not severed employment or attained age 59 ½ elects an in-plan Roth rollover of an amount attributable to pre-tax elective deferrals, that participant could not receive a distribution of those amounts, or the applicable earnings, from his or her designated Roth account prior to attainment of age 59½ or the occurrence of another distributable event under Section 401(k)(2)(B) of the Code.

Five-Year Period for Qualified Distributions

The Roth 401(k) rules provide that earnings are never taxed upon a “qualified distribution.” One of the requirements for a qualified distribution is that it must be made at least 5 years after a participant’s first contribution to a Roth account.

The Notice confirms that if an in-plan Roth rollover is the first contribution made to a participant’s designated Roth account, the 5-taxable year period required for a qualified distribution of Roth amounts begins on the first day of the first taxable year in which the participant elects the rollover.

Deadline to Amend Your Plan

The deadline to adopt a plan amendment to allow in-plan Roth rollovers of otherwise nondistributable amounts generally has been extended to the later of the last day of the first plan year in which the amendment is effective or December 31, 2014, provided the amendment is effective as of the date the plan first operates in accordance with the amendment. For example, if a plan with a June 30th year end permitted in-plan Roth rollovers of all pre-tax deferrals effective November 1, 2013, the deadline for amendment is extended from June 30, 2014 to December 31, 2014.

The Notice provides that safe harbor 401(k) plans are temporarily allowed to make this change mid-year. A 401(k) safe harbor plan that wishes to allow in-plan Roth rollovers of otherwise nondistributable amounts during 2013 or 2014 must adopt a plan amendment by December 31, 2014.

The deadlines above apply also apply for the following types of Roth amendments:

  • An amendment that permits elective deferrals to be designated as Roth contributions
  • An amendment that provides for acceptance of rollover contributions by designated Roth accounts
  • An amendment that permits in-plan Roth rollovers of some or all otherwise distributable amounts

Additionally, the Notice clarifies that subject to normal nondiscrimination requirements, a plan can limit the type of contributions eligible for an in-plan Roth rollover, as well as the frequency of rollovers. For example, a plan could choose to provide that only otherwise distributable amounts are eligible for in-plan Roth rollover. When deciding what type of in-plan Roth rollovers to offer (if any), a plan sponsor should balance the administrative costs of maintaining separate accounts for different types of in-plan Roth rollover amounts against the benefit to participants of the greater flexibility in retirement planning. Further, the Notice clarifies that the ability to make an in-plan Roth rollover is not a Section 411(d)(6) protected benefit and can generally be discontinued if desired.

Other Considerations

The Notice provides that:

  • Only direct rollovers of otherwise nondistributable amounts are allowed (i.e., the 60-day rollover period allowed for otherwise distributable amounts would not apply).
  • A Section 402(f) notice is not required to be provided to a participant making an in-plan Roth rollover of otherwise nondistributable amounts.
  • Plans must count these rollovers in determining the present value of accrued benefits for purposes of determining top-heavy status under Section 416 of the Code.
  • No withholding of federal tax under Section 3405 of the Code applies for these rollovers, and no part of the rollover may be withheld for voluntary withholding under Section 3402(p) of the Code. (The Notice advised that an employee making an in-plan Roth rollover may need to increase his or her withholding or make estimated tax payments to avoid an underpayment penalty.)
  • If an employee rolls over an amount into a Roth account which is later determined to be an excess amount, and the excess amount (plus applicable earnings) is to be distributed from the plan, then the excess amount (plus earnings) must be distributed from the designated Roth account, even if the amount was an otherwise distributable amount at the time of the in-plan rollover.
  • An in-plan Roth rollover is treated as a distribution for purposes of determining eligibility for the special tax treatment of net unrealized appreciation (NUA). Participants with employer stock in their plan accounts should consult with a personal tax advisor before electing an in-plan Roth rollover.

If you have any questions about these rules, please contact the Trucker Huss attorney with whom you normally work.