| The IRS has just released proposed regulations addressing Roth contributions to a 401(k) plan. The ability to make Roth contributions to 401(k) plans and 403(b) plans was added by EGTRRA (Code Section 402A) and will be effective for taxable years beginning on or after January 1, 2006. If permitted by a plan, participants in a 401(k) or 403(b) plan may designate that all or a portion of their elective deferrals be treated as Roth contributions. The designated Roth elective deferrals are taxed in the same manner as Roth IRA contributions; the contributions are subject to current income tax and withdrawals of the contributions, including income, are tax-free. However, unlike Roth IRAs, designated Roth contributions are not subject to gross income limitations on being able to make the contributions.
In order to be treated as a Roth contribution, a participant must irrevocably designate an elective deferral as a Roth contribution prior to the time the contribution is made to the plan. The plan must separately account for designated Roth contributions and earnings thereon, because such amounts are subject to different tax treatment than other amounts the plan may hold. For example, a plan may not allocate forfeitures to the designated Roth account and Roth 401(k) contributions may be rolled over only to another plan that permits designated Roth contributions or to a Roth IRA. A plan must maintain the separate accounts from the time Roth contributions are made to the plan until the Roth account is completely distributed.
While a plan may allow a participant to choose which amounts are pre-tax elective deferrals and which are after-tax Roth elective deferrals, the plan treats both types of deferrals as elective deferrals. Thus, the combined deferral amount may not exceed the Code Section 402(g) limits (e.g., $15,000 for 2006 plus, if catch-up eligible, $5,000). Roth contributions to a 401(k) or 403(b) plan do not affect the ability of a participant to make a separate Roth IRA contribution.
Because Roth contributions are still elective deferrals, they are aggregated with pre-tax elective deferrals for testing purposes (e.g., ADP testing). In addition, they are subject to the same vesting and distribution restrictions. The proposed regulations also permit a plan to provide for ordering rules with respect to a corrective distribution of a failed ADP test. A plan may permit the participant to elect the ordering of the distribution. If there is a corrective distribution of amounts from the Roth account, the Roth contributions are tax-free and the earnings on such amounts are includible in gross income.
The proposed regulations do not provide guidance regarding the timing of amendments to existing 401(k) plans to permit Roth contributions. However, absent further guidance from the IRS, IRS Notice 2001-42 provides that with respect to an optional provision of EGTRRA, a plan is required to be amended by the end of the plan year in which the optional provision is put into effect. At this point we do not know whether the IRS intends to issue any sample or good-faith amendments. However, regardless of any required plan amendment, an employer wishing to add the Roth contribution feature to its plan for 2006 must undertake necessary employee communications and must make certain that the employer’s recordkeeping and payroll systems are equipped to handle Roth contributions.
SunGard Corbel will provide a more detailed and practical discussion of the Roth 401(k) rules at our 401(k) Plan Workshop.
We are also presenting a
Web Seminar on the Roth 401(k) rules on March 29, 2005, at 2:00 p.m. ET.
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