On December 11, 2013, the IRS issued Notice 2013-74 to provide guidance regarding “in-plan Roth rollovers” (also commonly referred to as “in-plan Roth conversions”). This Notice builds on Notice 2010-84 which addressed in-plan Roth rollovers of amounts to the extent such amounts were otherwise distributable from the plan. With the enactment of the American Taxpayer Relief Act of 2012 (ATRA), the availability of in-plan Roth rollovers was expanded to include any vested amounts regardless of whether such amount is otherwise distributable. In other words, as long as the plan permits, any vested amount can now be converted from a non-Roth account to a Roth account.
Effective for distributions made after September 27, 2010, the Small Business Jobs Act of 2010 (“SBJA”) amended Section 402A of the Internal Revenue Code of 1986 (the “Code”) to permit a plan that includes a qualified Roth contribution program to allow employees to roll over amounts in the plan to their designated Roth accounts in the plan. To be eligible for an in-plan Roth rollover, the amount had to (i) be eligible for distribution under the Code (i.e., be an “otherwise distributable amount”) and (ii) be an eligible rollover distribution as defined in Code Section 402(c)(4).
ATRA again amended Section 402A of the Code to expand what amounts are eligible for an in-plan Roth rollover. Effective for in-plan Roth rollovers made after December 31, 2012, the new rules now permit in-plan Roth rollovers of vested amounts whether or not the amounts are otherwise distributable from the plan. In this article, we refer to in-plan Roth rollovers of non-distributable amounts as “ATRA rollovers,” and in-plan Roth rollovers of otherwise distributable amounts as “SBJA rollovers”.
Key provisions of Notice 2013-74
- Application of Notice 2010-84: In general, the rules set forth in Notice 2010-84 continue to apply to all in-plan Roth rollovers, including ATRA rollovers, with the following exceptions:
- While an SBJA rollover may be accomplished by a 60-day rollover, an ATRA rollover must be made by a direct rollover.
- A notice regarding eligible rollover distributions (commonly known as a 402(f) notice) is not required with respect to an ATRA rollover.
- New Amounts Eligible for In-Plan Rollovers: The following types of contributions (and earnings) are eligible for an ATRA rollover, without regard to whether the amounts satisfy the conditions for distribution:
- Elective deferrals made to 401(k) and 403(b) plans
- Matching contributions and nonelective contributions (including qualified matching and nonelective contributions)
- Deferrals made to governmental 457(b) plans
- Distribution Restrictions: ATRA rollover amounts and their earnings must remain subject to the distribution requirements that applied to such amounts before the roll over to a Roth account. For example, if a 401(k) plan participant who has not had a severance from employment makes an ATRA rollover prior to age 59 ½, the amount of the rollover (and earnings) may not be distributed prior to age 59 ½ or another permitted 401(k) plan distribution event.
- Withholding: Neither mandatory nor voluntary withholding may be applied to an ATRA rollover because there is no distribution event permitting money to leave a plan. Participants are encouraged to consider altering the amount of their wage withholding, or make estimated tax payments, if they wish to prepay an anticipated tax obligation to avoid a potential under-withholding penalty.
- Amendment Deadline: Plans that allow ATRA rollovers must be amended by the later of December 31, 2014, or the last day of the plan year in which the ATRA rollovers become effective. For example, in the case of a § 401(k) plan that has a calendar-year plan year and allowed an in-plan Roth rollover of an otherwise nondistributable amount during 2013, a plan amendment providing for that option must be adopted no later than December 31, 2014. Special rules discussed below apply to safe harbor 401(k) plans and certain 403(b) plans.
- Special Rules for 401(k) Safe Harbor Plans: Although most mid-year changes to 401(k) safe harbor plans are prohibited, plans that wish to provide for ATRA rollovers mid-year may do so for 2013 or 2014 if the amendment is executed no later than December 31, 2014. Beyond this deadline, 401(k) safe harbor plans will generally be required to modify plan provisions for in-plan Roth rollovers prospectively.
- Special Rules for 403(b) Plans: If an employer adopted a written 403(b) plan by December 31, 2009 (or, if later, the date the plan is established), the employer has a remedial amendment period to correct any form defects retroactive to January 1, 2010 (or the date the plan is established). Plans that allow ATRA rollovers must be amended by the last day of the 403(b) remedial amendment period, which will be announced by the IRS in the future. 403(b) plans that do not qualify for the remedial amendment period must meet the general amendment deadline described above.
- Covered Amendments: The extended amendment deadlines apply not only to a plan amendment to permit ATRA rollovers, but also to related amendments including: (i) a plan amendment that permits elective deferrals under the plan to be designated as Roth contributions; (ii) a plan amendment that provides for the acceptance of rollover contributions by designated Roth accounts; and (iii) a plan amendment that permits in-plan Roth rollovers of otherwise distributable amounts.
In addition to this specific guidance regarding ATRA rollovers, Notice 2013-74 also provides additional rules that relate generally to in-plan Roth rollovers, regardless of whether or not amounts are otherwise distributable (“Roth rollovers”).
- Plan-Prescribed Restrictions: Plans are allowed to restrict the kinds of contributions eligible for in-plan Roth rollover treatment and the frequency of such rollovers. For example, to simply recordkeeping, a plan could restrict Roth rollovers to deferral contributions and limit participants to one Roth rollover each year.
- Not Section 411(d)(6) Protected Benefits: An employee’s ability to make a Roth rollover is not a section 411(d)(6) protected benefit. However, any amendment that eliminates Roth rollovers must not discriminate in favor of current or former highly compensated employees.
- Qualified Distribution Five-Year Clock: If a Roth rollover is the first contribution made to a participant’s Roth account, the five-year clock necessary for a qualified, tax-free distribution begins on the first day of the first taxable year in which the employee makes the Roth rollover.
- Net Unrealized Appreciation Tax Treatment: A participant that receives a lump-sum distribution in a single tax year may be eligible for special tax treatment pertaining to the net unrealized appreciation (NUA) on any employer securities in the participant’s account. A Roth rollover is treated as a distribution when determining if a lump-sum distribution occurs within one taxable year, whether completed in a direct or indirect (60-day) rollover.
- Top-Heavy Determination: When calculating participant account balances to determine a plan’s top-heavy status, a Roth rollover is treated like any “related rollover” made between plans of the same employer. As a result, it is generally counted in the participant’s account balance for purposes of determining top-heavy status.
- Excess Contribution Amounts: If all or a portion of a participant’s Roth rollover is later determined to be an excess deferral, excess contribution or excess aggregate contribution (under the ADP/ACP tests), a corrective distribution to the participant must be made even if the amount was an otherwise non-distributable amount at the time of the rollover.