On December 11, 2013, the Internal Revenue Service (“IRS”) released Notice 2013-74 (the “Notice”) which provides guidance on “in-plan Roth rollovers” of amounts that are not distributable to participants under the terms of the plan.
An “in-plan Roth rollover” allows a participant in a 401(k) plan, 403(b) plan, or governmental 457(b) plan to transfer certain pre-tax amounts held in the plan to an after-tax Roth account maintained under the plan. An in-plan Roth rollover is treated as a taxable rollover distribution to the Roth account. In connection with the transfer, the participant is required to pay income tax in the year of the transfer on the amount transferred. As a result, the transferred amount and, if certain requirements are satisfied, related earnings will not be subject to income tax when distributed from the plan.
The Small Business Jobs Act of 2010 first permitted in-plan Roth rollovers, but only for amounts that were otherwise distributable under the terms of the plan. As a result, relatively few participants, generally only employees age 59 ½ or older, were eligible for in-plan Roth rollovers. The American Taxpayer Relief Act of 2012 expanded the availability of in-plan Roth rollovers to all pre-tax amounts held in 401(k), 403(b) and governmental 457(b) plans, even if such amounts are not otherwise distributable. Accordingly, an eligible plan may permit any participant, regardless of age or eligibility for a distribution, to elect an in-plan Roth rollover provided that the plan permits participants to make Roth contributions before any in-plan Roth rollovers occur.
Impact on Earlier Guidance on In-Plan Roth Rollovers
In 2010, the IRS first provided guidance on in-plan Roth rollovers in Notice 2010-84. The Notice confirms that its earlier guidance, including the requirement that amounts eligible for in-plan Roth rollovers must be vested, continues to apply to all in-plan Roth rollovers, with certain limited exceptions. For instance, the Notice explains that two requirements under the earlier guidance—that a plan must provide a 402(f) notice to a participant making an in-plan Roth rollover and that an in-plan Roth rollover may be accomplished by an in-plan Roth 60-day rollover—apply only to in-plan Roth rollovers of otherwise distributable amounts.
Rules Applicable to In-Plan Roth Rollovers of Amounts Not Otherwise Distributable
The Notice provides several rules applicable to amounts not otherwise distributable from a plan that can be rolled over to an employee’s designated Roth account. It first clarifies that amounts eligible to be rolled over into a designated Roth account include elective deferrals in 401(k) and 403(b) plans, matching contributions and nonelective contributions, and annual deferrals made to governmental 457(b) plans.
The Notice also provides that amounts not otherwise distributable that are rolled over to an employee’s designated Roth account remain subject to the distribution restrictions that were applicable to such amounts before the in-plan Roth rollover. Therefore, if a participant (who has not had a severance from employment) makes an in-plan Roth rollover from a pre-tax deferral account prior to age 59 ½, that rollover amount cannot be distributed to the participant prior to the participant’s attainment of age 59 ½ or the occurrence of another event that permits a pre-tax deferral account to be distributed under the terms of the plan.
The IRS also clarified that, for in-plan Roth rollovers of amounts not otherwise distributable, taxes are not required or permitted to be withheld from the rollover amount. Accordingly, participants should be aware that they will be required to pay income tax in the year of the conversion on the full amount transferred, without actually receiving a distribution from the plan to help pay those taxes, and may need to increase their withholding or make estimated tax payments to avoid an underpayment penalty.
The Notice sets forth rules regarding when plan amendments providing for in-plan Roth rollovers must be adopted to be effective for a plan year. Generally, a plan amendment providing for in-plan Roth rollovers of amounts not otherwise distributable qualifies as a discretionary amendment and, therefore, must be adopted no later than the last day of the first plan year in which the amendment is effective. The Notice extends the deadline for adopting plan amendments for in-plan Roth rollovers “to the later of the last day of the first plan year in which the amendment is effective or December 31, 2014.” Accordingly, for calendar-year plans, the plan may permit in-plan Roth rollovers of non-distributable amounts during 2013 as long as a plan amendment is adopted by December 31, 2014.
Additional Guidance Applicable to all In-Plan Roth Rollovers
The Notice also provides additional guidance applicable to all in-plan Roth rollovers, including the following:
- Ability to Restrict Contributions Eligible for In-Plan Roth Rollovers: Plans may limit the type of contributions eligible for an in-plan Roth rollover.
- Ability to Restrict Frequency of In-Plan Roth Rollovers: Plans may limit the frequency of in-plan Roth rollovers.
- Ability to Discontinue In-Plan Roth Rollovers: Plans with ongoing qualified Roth contribution programs may discontinue such programs because an employee’s ability to make an in-plan Roth rollover is not a protected benefit.
- Five-Taxable-Year Period of Participation: If an in-plan Roth rollover is the first contribution that the participant makes to the Roth account, the five-taxable-year period of participation required for a qualified distribution from the Roth account begins on the first day of the first taxable year in which the employee makes the in-plan Roth rollover.
- Top-Heavy Status: A plan must count an in-plan Roth rollover in determining the present value of accrued benefits for purposes of determining top-heavy status.
- Treatment of Excess Amounts Rolled into a Designated Roth Account: Any amount rolled over into a designated Roth account that is later determined to be an excess amount (such as an excess deferral contribution) must be distributed from the designated Roth account.