The IRS has resolved some of the uncertainty surrounding in-plan Roth rollovers in Notice 2013-74. Even though it is late in 2013, employers can still allow Roth contributions and in-plan Roth rollovers in 2013 without adopting plan amendments until the end of 2014.
1. What Is an In-Plan Roth Rollover?
Roth contributions have become an increasingly common feature in 401(k) plans. By one estimate, approximately half of the plans sponsored by large employers permitted Roth 401(k) contributions as of the beginning of 2013, and many more were considering adding the feature in 2013.
However, few plans permit participants to take existing 401(k) plan balances and convert them into Roth amounts by paying taxes on the amount converted — so-called “in-plan Roth rollovers.” Although plans have been permitted to allow in-plan Roth rollovers since the 2010 plan year, the limited nature of these rollovers (only amounts that were already eligible to be distributed from the plan could be rolled into a Roth) made them less attractive to plan sponsors and participants.
This limitation changed as of January 1, 2013, and plans are now permitted to allow in-plan Roth rollovers of additional amounts. However, the uncertainty regarding what could be rolled over and the rules for administering these rollovers kept many plan sponsors from incorporating this feature. The IRS has now resolved some of this uncertainty.
2. Which Assets Can Be Rolled Over?
Any vested amount (including both contributions and earnings) can be rolled over if it is from one of the following sources:
- elective deferrals in a 401(k) or 403(b) plan;
- employer matching and non-elective contributions; and
- annual deferrals into a governmental 457(b) plan.
Employee after-tax (non-Roth) contributions generally cannot be rolled over into a Roth account.
In addition, as was permitted since 2010, amounts that are eligible for distribution — regardless of the source — can be rolled over into Roth accounts within a plan. As a result, plans could already allow in-plan Roth rollovers of amounts that have been rolled into a plan from another plan.
3. What is the Deadline for Adopting Plan Amendments?
Employers with calendar year 401(k) or governmental 457(b) plans have until December 31, 2014, to adopt the necessary plan amendments:
- to permit in-plan Roth rollovers (of nondistributable or distributable amounts, or both) in 2013 or 2014;
- to allow elective deferrals to be designated as Roth contributions in 2013 or 2014; and
- to accept rollovers of Roth amounts (other than in-plan rollovers) in 2013 or 2014.
This deadline allows employers to permit Roth contributions and in-plan Roth rollovers in 2013 without having to adopt the necessary amendments until December 31, 2014. A similarly generous deadline for 403(b) plans will be announced at a later date.
4. What Administrative Challenges Are There for Plan Sponsors?
Two sets of rules now apply to in-plan Roth rollovers: one under Notice 2010-84 that applies to in-plan Roth rollovers of amounts that are otherwise distributable, and one under Notice 2013-74 that applies to in-plan Roth rollovers of amounts that are not distributable. Plan sponsors considering allowing in-plan Roth rollovers to the fullest extent permitted by law should consider the following recordkeeping issues:
Non-Distributable Amounts Notice 2013-73
|Type of Rollover Permitted||May be accomplished by direct or indirect rollover; indirect rollovers remain subject to requirement that amount generally be rolled back into the plan within 60 days.||May be accomplished by direct rollover only.|
|402(f) Notice||Participant must receive a 402(f) notice, and model notice likely should be modified to address possibility of in-plan Roth rollover if permitted.||No 402(f) notice is required because amounts cannot be distributed.|
|Distribution Restrictions||Amounts rolled over in an in-plan Roth rollover (and related earnings) can be distributed at any time.||Amounts rolled over in an in-plan Roth rollover (and related earnings) can only be distributed if there is a distributable event, such as a severance from employment.|
|Withholding||Withholding required on indirect rollovers, and plan may withhold additional amounts at participant’s request.||No withholding required, and plan cannot withhold at participant’s request. Employer should consider informing participant of need to adjust withholding outside of plan or pay estimated taxes to avoid penalties.|
5. What Other Issues Are Addressed in the Notice?
Notice 2013-74 addresses a number of other issues, including:
- Safe Harbor Plans. Safe harbor plans, which generally cannot make mid-year changes, are permitted to make mid-year changes in 2013 or 2014 to allow in-plan Roth rollovers of non-distributable amounts.
- Restrictions. Employers are permitted to restrict the frequency of in-plan Roth rollovers and the types of accounts that can be rolled over, subject to the general nondiscrimination requirements.
- Protected Right. The right to make an in-plan Roth rollover is not a protected benefit, so employers can take it away later if it proves too complicated to administer.
- Five-Year Holding Period. If an in-plan Roth rollover is a participant’s first Roth contribution, the five-year period of participation required for Roth treatment begins to run on the first day of the taxable year in which the rollover is made.
The notice also sets forth special rules applicable to net unrealized appreciation in employer securities, top-heavy issues, and distributions of excess amounts.