The long-awaited Roth distribution proposed regulations are out, with more than we expected. Here are some highlights from the proposals:
What do the proposed regulations include?
The package includes:
- Proposed regulations under Code §402A on the taxation of Roth plans
- Additional proposed regulations under Code §408A dealing with rollovers from Roth plans to Roth IRAs
- Proposed amendments to the 402(g) regulations dealing with excess deferrals, including gap period income rules applicable to both Roth and pre-tax deferrals
- Proposed amendments to the 403(b) proposed regulations to add Roth to 403(b)
If a participant receives a partial distribution from a plan with both Roth and pre-tax accounts, how much comes from the Roth account?
Apparently, the participant or the plan can specify.
What are the requirements for a qualified distribution from a Roth plan?
A participant must satisfy two requirements to have a tax-free distribution of income (a qualified distribution) from a Roth plan:
- The participant’s 5-year-taxable period (the “5-year clock”) must have elapsed, and
- The participant must be 59½, dead, or disabled.
Are there any Roth distributions which can never be qualified distributions?
Yes. Corrective distributions to correct 402(g), ADP, ACP, or 415 failures cannot be qualified distributions. Neither can loan default deemed distributions, the cost of current life insurance protection, or certain dividend distributions, be qualified distributions.
When does a participant’s 5-year clock start for a Roth plan?
The clock starts for a calendar year participant (which is essentially all participants) on January 1 of the calendar year the participant first makes a Roth deferral to the plan.
Can you roll over a Roth plan distribution? How?
A participant can do a direct plan-to-plan rollover of a Roth distribution from one 401(k) plan to another 401(k) plan, or from a Roth 403(b) plan to another Roth 403(b) plan. Alternatively, a participant can make a plan-to-plan or 60-day rollover of a distribution from a Roth plan to a Roth IRA. A participant can roll to a Roth IRA even if the participant’s adjusted gross income was sufficiently great that the participant would be barred from making a Roth IRA contribution.
If a participant wants to do a 60-day rollover of a Roth plan distribution to another Roth plan, the participant may roll over only the income. In that case, the recipient plan will be required to inform the IRS of the rollover.
If a Roth plan does a plan-to-plan rollover to another Roth plan, the distributing plan must inform the recipient plan, within 30 days, either: (1) that the distribution is a qualified distribution; or (2) the amount of the participant’s basis and the year the participant’s 5-year clock started to run. If a Roth plan distributes the amount to the participant, the participant can request a similar written statement.
How is the 5-year clock handled in rollover situations?
If a participant rolls a Roth distribution from plan A to plan B, the 5-year clock in plan B starts on January 1 of the earlier of:
- The year the participant first made a Roth deferral to plan B or
- The year the participant first made a Roth deferral to plan A
The 5-year clock for Roth IRAs is totally separate from the 5-year clock for Roth plans. Thus, if a participant has never made a Roth IRA contribution before, the rollover will start the Roth IRA 5-year clock.
If a participant receives a partial distribution from a Roth plan account, and the distribution isn’t a qualified distribution, how much is taxable?
Partial distributions from Roth plans distribute income pro-rata. So, suppose John’s Roth account balance is $10,000, of which $1,000 is income, and he receives a nonqualified distribution of $4,000. $3,600 of the distribution is nontaxable return of John’s deferrals and the remaining $400 is taxable income.
How does a Roth plan handle hardship distributions?
This is a more complex area than many previously supposed. The maximum hardship distribution a 401(k) plan can make to a participant is the total of the participant’s elective deferrals (Roth and pre-tax), reduced by prior hardship distributions. Income on deferrals, QNECs, and QMACs are not included in computing this limitation. There is no limit on hardship distributions from regular profit sharing and matching contribution accounts. This limit is not affected by the taxation of the distributions. It is a limitation on amount, not a limitation on source.
Suppose Sue (40) who has never had a prior hardship distribution, has the following elective deferral accounts:
| |
Pre-tax |
Roth |
Total |
| Deferrals |
$17,000 |
$9,000 |
$26,000 |
| Income |
$3,000 |
$1,000 |
$4,000 |
| Total |
$20,000 |
$10,000 |
$30,000 |
Sue receives a hardship distribution of $10,000. She can choose to have the distribution come from the pre-tax account or the Roth account (unless the plan document restricts her choice). If the distribution came from the Roth account, Sue would pay tax on the $1,000 of income. (If the distribution were only $5,000 and came from the Roth account, Sue would pay tax on $500 of income.) The $1,000 would also be subject to the 10% premature distribution penalty. Alternatively, if Sue took the distribution from the pre-tax account, Sue would pay tax and penalty on the entire $10,000.
Before the distribution, Sue is limited to a total of $26,000 of hardship distributions from her elective deferrals. After the distribution, regardless of the account from which Sue took her distribution, she is limited to a total of $16,000 of additional hardship distributions.
How does a plan handle participant loans from a Roth account?
A plan should know at the outset whether a loan comes from a participant’s pre-tax accounts on the participant’s Roth accounts. This will affect allocation of income as the participant repays the loan. The level amortization requirement applies separately to the Roth and non-Roth portions of the loan. If the participant defaults and a deemed distribution occurs, the Roth portion would be a nonqualified distribution, regardless of the 5-year clock or the participant’s age.
Conclusion
The proposed rules are much more detailed than this summary, and include considerations of QDROs, 403(b) plans, excess deferrals, and more. Three upcoming programs will discuss these rules in more detail:
Our February 14 Web Seminar: Roth - The Pieces Are Coming Together will focus on the distribution rules.
Our February 22-24 Advanced Pension Conference in Orlando will have a presentation devoted to Roth.
Our 401(k) Plan Workshops in April and May will provide detailed coverage of the new rules. Online registration for this program will be available mid-Febuary. And, watch your mail for a brochure.
|
