The Small Business Jobs Act of 2010, which was signed into law by President Obama on September 27, 2010, expands the current Roth contribution and conversion rules for 401(k), 403(b), and governmental 457(b) plans. Employers must quickly decide whether they wish to implement these changes in their defined contribution retirement plans.
In-Plan Roth Conversions. The Act allows employers to amend their plans to provide for Roth conversions within 401(k), 403(b), and governmental 457(b) plans.
New rules that went into effect January 1, 2010, allow all plan participants, regardless of their modified adjusted gross income, who are eligible to receive a plan distribution (typically because they have terminated employment or attained age 59½) to elect to roll over amounts from a 401(k), 403(b), or governmental 457(b) plan to a Roth IRA. Such rollovers are taxable in the year of distribution, although a special tax rule allows participants to defer the tax due on 2010 rollovers into 2011 and 2012.
The Act now permits plan participants to leave their money in their plan accounts and still take advantage of the Roth rollover rules if certain requirements are met. First, the plan must allow for "Roth contributions." Roth contributions are made on an after-tax basis, and investment earnings accumulate tax-free if the contributions are held in the plan for at least five years. Second, a participant must have had a distribution event under the terms of the plan. Some employers may wish to amend their plans to expand the distribution options to allow more participants to take advantage of Roth conversions. For example, a plan could be amended to allow for in-service withdrawals for all employees who have attained age 59½ or for the withdrawal of employer contributions that have been held in the plan for a fixed number of years. New distribution options may be limited to only those participants who request an in-plan Roth conversion.
Although it appears that the Internal Revenue Service will provide a remedial amendment period for plan sponsors to amend their plans for Roth conversions, plan sponsors should decide now whether they will allow such conversions so that participants can take advantage of the 2010 special tax rules.
Governmental 457(b) Plans May Now Permit Roth Contributions. The Act also allows governmental employers to amend their section 457(b) plans, effective January 1, 2011, to allow participants to designate their elective deferrals as Roth contributions. A similar plan feature already applies to 401(k) and 403(b) plans. Governmental employers that wish to allow Roth contributions as of January 1, 2011, should contact their plans’ vendors and start making payroll and human resources system adjustments now. Section 457(b) plan documents will need to be amended to reflect the ability to make Roth contributions.