On May 17, 2016, the Internal Revenue Service (IRS) issued final regulations that remove the current allocation rule and treat distributions from a Roth account made to multiple destinations as a single distribution beginning on January 1, 2016 (81 Fed. Reg. 31165). The final regulations generally adopt the proposed regulations (see Legal Update, IRS Issues Proposed Rules on Allocation of After-Tax Amounts from Roth Accounts) with a one-year delay of the applicability date..

A Roth 401(k) account or designated Roth account combines elements of both a Roth IRA and a traditional 401(k) plan. The designated Roth account:

(See Practice Note, Roth 401(k) Plans.)

Generally, an amount distributed from a designated Roth account is taxable to the participant, unless the amount is rolled over into an eligible account that is not taxable (see Practice Note, Roth 401(k) Plans: Distributions from Roth 401(k) Accounts and Rollovers to Other Roth Accounts). Under the current rules, if a designated Roth account includes both after-tax and pre-tax amounts, each distribution from the account will include a pro-rata share of both after-tax and pre-tax amounts.

A participant may elect to distribute one amount from a designated Roth account to multiple destinations. For example, a participant may roll over a portion of the amount to an eligible account and distribute the other portion to himself. Under the current rules, each portion is treated as a separate distribution (Treas. Reg. § 1.402A-1, Q&A-5(a)). Consequently, under IRS Notice 2009-68, each distribution includes a pro-rata share of the after-tax and pre-tax amounts.

In September 2014, the IRS issued proposed regulations in response to comments received on Notice 2009-68 indicating confusion among plan providers regarding the application of the allocation rule and what happens when a participant distributes pre-tax and after-tax funds to multiple destinations. Under the proposed rules, the current allocation rule would be removed and distributions from a Roth account made to multiple destinations would be treated as a single distribution if the distribution was made either:

In conjunction with the proposed rules, the IRS issued Notice 2014-54 which explains the new allocation rules for after-tax and pre-tax amounts. For more information, see Legal Update, IRS Issues Proposed Rules on Allocation of After-Tax Amounts from Roth Accounts.

The final regulations generally adopt the proposed regulations with a one-year delay of the applicability date. The regulations remove the current allocation rule and treat a distribution made to multiple destinations as a single distribution if the distribution is made either:

As a result of this change:

Distributions made prior to January 1, 2016 will be subject to the separate distribution rule, unless the taxpayer elects not to apply the separate distribution rule to distributions that are made during the transition period (September 18, 2014 to January 1, 2016). Taxpayers choosing not to apply the separate distribution rule to distributions made during the transition period must apply a reasonable interpretation of Internal Revenue Code (Code) Section 402(c)(2) (generally requiring that pre-tax amounts be treated as rolled over first) to allocate pre-tax and after-tax amounts among disbursements made to multiple destinations. A "reasonable interpretation" includes the rules described in Notice 2014-54.

The final regulations are effective May 18, 2016. They apply retroactively to distributions from designated Roth accounts made on or after January 1, 2016 (or an earlier date chosen by the taxpayer that is on or after September 18, 2014).

Previously, there was a complicated mechanism that participants used in order to distribute after-tax and pre-tax amounts to multiple destinations. This mechanism was confusing among practitioners and providers, and resulted in much disagreement. These final regulations provide practitioners and providers with more comfort and a simplified process so that after-tax and pre-tax amounts can be distributed to multiple destinations. Practitioners and providers should also be aware that the final regulations adopt a one-year delay of the applicability date included in the proposed regulations.