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Industry Group Warns of Risks in Roth 401(k) Conversion Law
Waiting for IRS regulations in 2011

Stephen Miller  11/1/2010
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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 website, here.

A Compliance Alert from The SPARK Institute, representing the retirement plan services industry, warns of potential risks for sponsors and participants of 401(k) and 403(b) retirement plans from a new law that permits participants to convert funds from traditional pre-tax plan accounts to post-tax Roth accounts inside the plans (see "Roth Conversions within 401(k) Plans Now Permitted").

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 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 must be paid on the converted funds.

SPARK Institute General Counsel Larry H. Goldbrum pointed out that the conversion law is effective immediately, creating a sense of urgency among some plans participants who want to take advantage of a two-year special tax treatment window for 2010 conversions. “However, we urge plan sponsors to carefully consider the potential risks that Roth conversions may create for the plan as a whole, and not base their decisions solely on the potential benefits to individual highly compensated employees who may be personally interested in the 2010 special tax treatment,” Goldbrum said.

He noted that U.S. Treasury Department officials have urged caution. In recent statements, Mark Iwry, senior advisor to the Secretary of the Treasury and deputy assistant secretary, and William Bortz, associate benefits tax counsel at the Treasury, have suggested that plan sponsors wait for upcoming guidance before drafting any plan amendments. In addition, trade groups have asked the Treasury Department and the IRS to issue guidance (for example, via this letter from the Investment Company Institute and this letter from the American Benefits Council).

Unresolved Issues

According to The SPARK Institute alert, unresolved issues requiring guidance from the Treasury include: 

Tax withholding. The new law does not specify whether the distribution portion of the conversion is subject to the mandatory 20 percent withholding requirement on distributions.

Plan amendments. It's unclear whether a plan that does not currently allow Roth accounts can be amended to add them along with an in-plan conversion feature during the remedial amendment period that is applicable for plans that already allow Roth accounts.

Recordkeeping/administration. The new law does not indicate how and if plan conversion amounts must be segregated from regular Roth deferrals for record keeping purposes.

“Logically, additional guidance should require a separate account for tracking the converted Roth amounts. However, laws are not always interpreted in logical ways and the guidance may have surprises,” notes benefits attorney Fred Reish of the law firm of Reish & Reicher. He suggests that “the better approach, for risk management purposes, is to wait until the guidance is issued.”

Additional Concerns

The v said other issues that sponsors should consider include:

No recharacterization. An in-plan Roth conversion is irrevocable and cannot be recharacterized after it is made, in contrast to a Roth individual retirement account (IRA), which can be revoked before the participant’s tax filing deadline.

Roth IRA rollovers. Rolling over funds from a traditional 401(k) into a Roth IRA (for plans that permit in-service distributions) remains a viable option for otherwise eligible participants who want to take advantage of the special two-year tax treatment window in 2010, and involves significantly less risk for plan sponsors and participants pending clarifying IRS guidance.

“Plan sponsors should consider all these issue carefully, be mindful of the implications of the plan as a whole, and consult with legal counsel if they remain interested in permitting 2010 conversions,” Goldbrum advised.

Stephen Miller is an online editor/manager for SHRM.

Related Article—External:

Roth 401k Conversion: Pros and Cons,, October 2010

Related Articles—SHRM:

IRS Issues Guidance on Roth 401(k) Conversions, SHRM Online Benefits Discipline, December 2010

Roth Conversions within 401(k) Plans Now Permitted, SHRM Online Benefits Discipline, September 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

Quick Link:

SHRM Online Benefits Discipline

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