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In-plan Roth Rollovers: Do They Make Sense for Your 401(k) Plan?
Practical Law Legal Update 9-559-6665 (Approx. 5 pages)
In-plan Roth Rollovers: Do They Make Sense for Your 401(k) Plan?
by Practical Law Employee Benefits & Executive Compensation
| Published on 04 Mar 2014 • USA (National/Federal) |
This resource discusses whether plan sponsors of 401(k) plans should consider adding an in-plan Roth rollover to their plan. The in-plan Roth rollover permits participants to rollover their eligible non-Roth accounts to a Roth option within the same plan so that participants do not have to remove funds from their employer's plan to participate in a Roth account.
As of September 27, 2010, plan sponsors of 401(k) plans are permitted to offer their participants an in-plan Roth rollover. This feature allows participants to rollover their eligible non-Roth accounts to a Roth option within the same plan so participants do not have to remove funds from their employer's plan to participate in a Roth account. An in-plan Roth account permits designated Roth contributions to grow with tax-free earnings and are distributed at retirement without triggering any future income tax liability.
Before passage of the American Taxpayer Relief Act of 2012 (ATRA), a distributable event was required for a participant to make an in-plan Roth rollover. Due to a change made by ATRA, a distributable event is no longer required for a participant to make an in-plan Roth rollover, which has increased interest in in-plan Roth rollovers by both plan sponsors and participants. Participants may want to convert pre-tax accounts to Roth accounts if they believe that their tax rate during retirement will be lower than their current tax rate. Plan sponsors with employee populations that include particularly sophisticated investors with large 401(k) account balances may wish to add this feature to their plans to satisfy participant demand.
Requirements for In-plan Roth Accounts
Some of the more significant requirements for in-plan Roth accounts include that:
- Plan sponsors must have a pre-existing designated Roth account option available to offer an in-plan rollover. In-plan Roth accounts cannot be designed solely to accept rollover contributions from Roth accounts, but must also accept designated Roth elective deferrals.
- Before 2013, only distributable amounts were eligible to be rolled over into a Roth account. However, due to a change made by the ATRA, amounts rolled over no longer need to be eligible for distribution to participants (see No Distributable Event Requirement).
- Unlike Roth IRAs, rollovers to a designated Roth account from a traditional pre-tax account are irreversible when done.
- Because an in-plan Roth rollover allows participants to roll over funds from a pre-tax account to an after-tax Roth account, the taxable amount of any in-plan rollover distribution must be included in the participant's gross income. However, an in-plan Roth rollover of an otherwise nondistributable amount does not require withholding by the plan sponsor. Therefore, plan sponsors must account for in-plan Roth rollovers of otherwise nondistributable amounts and related earnings separate from regular Roth rollover amounts.
Early Withdrawal Penalty Rules
The IRS generally does not impose a 10% early withdrawal penalty on funds rolled over from a pre-tax account to a designated Roth account.
However, if a participant withdraws any part of the in-plan rollover from the designated Roth account within five years of the rollover, the participant's withdrawal is subject to the 10% penalty on early distributions under IRC Section 72(t) unless:
- The distribution is allocable to a nontaxable portion of the in-plan rollover.
- An exception applies.
No Distributable Event Requirement
Before 2013, a plan sponsor was permitted to amend its plan to add distribution options beyond those currently offered to take advantage of the in-plan Roth rollover, for example, by allowing in-service distributions for participants over age 59½. As a result of the changes made by the ATRA, this type of amendment is no longer required for plan participants to effectuate an in-plan Roth rollover. The amount rolled over and applicable earnings remain subject to any distribution restrictions applicable to the amount before the in-plan Roth rollover.
However, plan sponsors need not implement this change and can continue to require a distributable event for in-plan Roth rollovers.
Deadline for In-plan Roth Rollover Amendments
The deadline for plan sponsors to adopt an amendment offering in-plan Roth rollovers is the last day of the plan year in which the amendment is effective.
A special plan amendment rule applies for safe harbor 401(k) plans (see Practice Note, Safe Harbor 401(k) Plans: Overview and Planning Opportunities).