The Internal Revenue Service (IRS) has issued guidance addressing in-plan Roth rollovers, which are rollovers of 401(k) plan balances to a Roth account in the same plan. The guidance focuses primarily on rollovers of balances that are not otherwise available for immediate distribution — such as where the account holder is not yet age 59½ — although it also addresses some issues that apply to all in-plan Roth rollovers.
According to Towers Watson’s Benefits Data Source, of 822 employers that sponsor a savings plan, slightly more than 50% offer a Roth 401(k) option. The new guidance could prompt other sponsors to evaluate whether to add a Roth 401(k) option to their plans. Sponsors of plans that already have a Roth rollover feature might want to benchmark their practices against this guidance.
In-plan Roth rollovers of amounts currently distributable have been allowed since 2010, while rollovers of otherwise nondistributable balances have been allowed since 2013. In-plan Roth rollovers may take the form of a direct rollover or of a distribution of funds to the account holder, who then rolls over the funds into a designated Roth account within 60 days (called an in-plan Roth 60-day rollover). The taxable amount of the transferred balance must be included in the account holder’s gross income, although the rollover is not subject to the 10% additional tax on early distributions.
In-plan Roth rollovers of otherwise nondistributable balances
In general, an in-plan rollover of an otherwise nondistributable amount is subject to the same rules as any other in-plan Roth rollover. However, nondistributable amounts must be rolled over directly to the Roth account; in-plan Roth 60-day rollovers are not allowed because a distribution of these funds would violate distribution restrictions.
Eligible amounts: In-plan Roth rollovers are available for balances attributable to elective deferrals (under a 401(k) or a 403(b) plan), matching contributions and nonelective employer contributions (including qualified matching contributions and qualified nonelective contributions). They are also available for annual deferrals made to a governmental 457(b) plan.
Rolled-over balances that were nondistributable remain subject to their original restrictions. For example, after being rolled over to the Roth account, 401(k) elective deferrals may not be distributed before the participant turns age 59½ or separates from service. So plan sponsors that allow such rollovers must track all applicable restrictions.
Withholding: An in-plan rollover of an otherwise nondistributable amount is not subject to income tax withholding, so no special tax notice is required from the plan. The account holder, however, might need to increase withholding or make estimated tax payments to avoid an underpayment penalty.
Plan amendments: An in-plan Roth rollover is generally a “discretionary” amendment, meaning it must be adopted by the last day of the first plan year in which the change took effect. However, the guidance includes an extended amendment deadline of December 31, 2014, or, if later, the last day of the first plan year in which the amendment is effective. This deadline applies to both safe harbor and non-safe harbor 401(k) plans (safe harbor plans will not be able to add an in-plan Roth rollover feature midyear after 2014). A similar 2014 deadline applies to governmental 457(b) plans, and the amendment deadline might, in certain circumstances, be even later for 403(b) plans.
So, a 401(k) plan sponsor that has already implemented an in-plan Roth rollover of otherwise nondistributable amounts, or that wants to do so, now has a limited extension for adding enabling provisions to its plan document. This same extended deadline also applies to related amendments to (1) allow elective deferrals to be designated as Roth contributions, (2) provide for the Roth account to accept rollover contributions and (3) permit in-plan Roth rollovers of otherwise distributable amounts. It is not clear whether these other amendments are covered by this relief only if the amendment also provides for an in-plan rollover of otherwise nondistributable amounts.
Additional guidance for all Roth rollovers
Notice 2013-74 also provides some guidance on miscellaneous issues related to in-plan rollovers:
- Plans may restrict the types of contributions and balances eligible for in-plan Roth rollovers, such as limiting rollovers to balances that are otherwise distributable. This would avoid the burden of tracking distribution restrictions for some or all of the Roth balances.
- Plan sponsors may eliminate in-plan rollovers at any time, although the timing must not discriminate in favor of highly compensated employees.
- Favorable tax treatment applies only to Roth distributions made after five years from the date the Roth account was established. When the first contribution made to an employee’s Roth account is an in-plan rollover, the five-year clock applies and begins on the first day of the first taxable year of the rollover.