Update: 'Fiscal Cliff' Law Eases Roth 401(k) Transfers
On Jan. 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 (H.R. 8), which was signed into law the following day. The legislation permits participants in pretax 401(k)s, 403(b)s and similar defined contribution retirement plans to elect to transfer amounts to a designated Roth 401(k) account, if available in their plan, at any time, with the transfer treated as a taxable qualified rollover contribution. While participants must pay income tax on funds transferred to the Roth 401(k) account, disbursements from the Roth account paid during their retirement years are made tax-free.
Employers must amend their plans to first allow for in-plan Roth 401(k) conversions.
Previously, converting funds from a pretax to a Roth 401(k) account was limited to money that was already "distributable" without penalty from the pretax plan—typically when an employee reached age 59½ or terminated employment, unless the plan otherwise allowed in-service distributions.
See "'Fiscal Cliff' Law Affects Payroll Tax Withholding and Employee Benefits."
Update: IRS Issues Guidance on In-Plan Roth Rollovers
On Nov. 26, 2010, the IRS issued Notice 2010-84, containing guidance for 401(k) and 403(b) plans about in-plan Roth rollovers—a feature that permits plan participants to convert eligible rollover distributions made after Sept. 27, 2010, from a non-Roth account into a designated Roth account in the same plan.
To learn more, see the SHRM Online article "IRS Issues Guidance on Roth 401(k) Conversions." In addition, more information is posted on the IRS.gov website, here.
A defined contribution retirement plan that includes a designated Roth program is now permitted but not required to allow employees (and surviving spouses) to roll over existing account funds into the Roth option, under a provision in the Small Business Jobs and Credit Act signed into law by President Barack Obama on Sept. 27, 2010.
Under the new law, participants in 401(k) and other defined contribution plans can convert some or all of their account balances into the Roth account provided under the plan—such as a Roth 401(k)—with no tax penalties, although income taxes on the distribution must be paid.
However, unless the plan allows in-service distributions, the plan will have to be amended to specifically allow a distribution from the traditional 401(k) into the available Roth option. The Joint Committee on Taxation's Technical Explanation of the bill explains the provisions regarding Roth conversions (see pages 39-43). According to the Joint Committee:
"Under the provision, if a section 401(k) plan, section 403(b) plan, or governmental section 457(b) plan has a qualified designated Roth contribution program, a distribution to an employee (or a surviving spouse) from an account under the plan that is not a designated Roth account is permitted to be rolled over into a designated Roth account under the plan for the individual. . . .
"Further, the distribution to be rolled over must be otherwise allowed under the plan. For example, an amount under a section 401(k) plan subject to distribution restrictions cannot be rolled over to a designated Roth account under this provision. However, if an employer decides to expand its distribution options beyond those currently allowed under its plan, such as by adding in-service distributions or distributions prior to normal retirement age, in order to allow employees to make the rollover contributions permitted under this provision, the plan may condition eligibility for such a new distribution."
In other words, the plan may be amended to allow in-service distributions limited to carrying out a Roth conversion.
IRAs Not the Only Option
For plans so amended, "the new provision permits a 401(k) plan to handle Roth conversions within the 401(k) plan—allowing participants to take advantage of Roth conversion rules without forfeiting the protection and advantages of holding savings in an employer-sponsored retirement program," commented Brian H. Graff, executive director and CEO of the American Society of Pension Professionals & Actuaries (ASPPA).
Prior to the new law, Graff explained, the conversion to a Roth account was only available by rolling over funds from a traditonal 401(k) into a traditional individual retirement account (IRA), typically at retirement or when leaving employment—or at death—and then converting those funds into a Roth IRA. Now, "workers won’t have to give up the advantages of an ERISA-protected 401(k) plan to take advantage of a Roth conversion," Graff said.
Remedial Period Expected
According to a release from law firm Jackson Lewis, the IRS is expected to provide a remedial amendment period to allow employers to offer employees (and surviving spouses) a Roth conversion option for distributions during 2010, and then have sufficient time to amend the plan to reflect this feature.
Stephen Miller is an online editor/manager for SHRM.
In-Plan Roth Conversion Issues, McKay Hochman, October 2010
Rollovers to 401(k), 403(b), and 457(b) Designated Roth Accounts Newly Permitted, Milliman, September 2010
IRS Issues Guidance on Roth 401(k) Conversions, SHRM Online Benefits Discipline, December 2010
Small Business Jobs Act Affects 401(k), 403(b), and 457(b) Plans, SHRM Online Legal Issues, September 2010
Roth 401(k)s Are Catching On, SHRM Online Benefits Discipline, September 2010
The Roth 401(k): A 'Value Add' for Your Employees, SHRM Online Benefits Discipline, updated August 2010
SHRM Online Benefits Discipline