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Guest Article

Deloitte logo

(From the December 6, 2010 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Guidance Allows 401(k) and 403(b) Plans to Quickly Add Roth Conversion Features


IRS guidance on "in-plan Roth rollovers" - a new feature that was created by the Small Business Jobs Act in September 2010 - will allow plan sponsors to quickly add the feature to existing 401(k) and 403(b) plans if the administrative support is in place. Amendments to 401(k) plans are not required before December 31, 2011. In-plan Roth rollovers made in 2010 will have the same special tax treatment as Roth IRA rollovers made that year (i.e., half of the taxable amount will be included in income in 2011 and half in 2012, unless the individual elects to include the full taxable amount in income in 2010).

IRS Notice 2010-84 explains the critical aspects of in-plan Roth rollovers. While a portion of the guidance focuses on how the new "in-plan Roth rollover" feature can be added to a plan, the bulk of the guidance addresses those aspects which will impact plan administration.

Key Administrative Aspects of In-Plan Roth Rollovers

From an administrative perspective, the notable aspects of in-plan Roth rollovers include the following:

  • Treatment as a Distribution. An in-plan Roth rollover is not treated as a distribution for purposes of:

    • Plan loans. Loans that are transferred in an in-plan Roth rollover are not considered to be new loans if the payment schedule remains the same. As a result, the restrictions applicable to loan refinancing under Code § 72(p) do not apply.
    • Spousal consent. Married participants are not required under Code § 411(a)(11) to obtain spousal consent for an in-plan Roth rollover.
    • Right to defer. The amount rolled over continues to be taken into account in determining whether a participant's accrued benefit exceeds $5,000 under Code § 411(a)(11), and notice of the right to defer distribution is not required for the rollover.
    • Optional forms. Distribution rights (e.g., the right to an immediate distribution of the amount rolled over) cannot be eliminated by an in-plan Roth rollover.
  • Unwinding the Rollover. Unlike rollovers to Roth IRAs, participants who elect an in-plan Roth rollover cannot later elect to unwind or recharacterize the rollover.
  • Tax Treatment. In-plan Roth rollovers are not subject to the 20% mandatory withholding. The taxable amount of the rollover is includible in the participant's income in the taxable year in which the distribution occurs. However, an exception applies for rollovers in 2010, by which half of the taxable amount is included in income in 2011 and half in 2012 unless the participant elects to include it all in income in 2010. That election applies to all in-plan Roth rollovers made by the individual in 2010, and cannot be changed after the due date (including extensions) for filing the individual's tax return. (Notably, the election is independent of the participant's election regarding rollovers he or she made to a Roth IRA in 2010.) If a participant does defer income inclusion to 2011 and 2012 and takes distribution in 2010 or 2011 of an amount that would otherwise not be included until a later year, income acceleration will apply. Income acceleration would not apply if the amount is rolled over to another designated Roth account or to a Roth IRA, however. In-plan Roth rollovers are separately accounted for within the plan's designated Roth account. The basis recovery rules under Code § 72 and Treasury Regulation § 1.402A-1, Q&A-9 apply in determining how an amount distributed from the plan is allocated to the taxable portion of an in-plan Roth rollover for purposes of applying the income acceleration and 5-year recapture rules.
  • 5-Year Recapture and 10% Penalty. Similar to the 5-year recapture rule applicable to Roth IRAs, if an amount allocable to the taxable portion of an in-plan Roth rollover is distributed within five years following the rollover (i.e., within the five-taxable year period beginning with the first day of the participant's taxable year in which the rollover is made), the distribution is includible in income. In that case, the 10% early distribution penalty under Code § 72(t) will also apply to the taxable portion unless an exception under Code § 72(t)(2) pertains - such as where distribution is made after the attainment of age 59?, or after separation from service after the attainment of age 55.

Adding an In-Plan Roth Rollover Feature

The Notice confirms that any vested amount held in a participant's account (other than amounts held in a designated Roth account) are eligible for an in-plan Roth rollover if a distribution is permitted (and the distribution is rollover eligible). For 401(k) plans, this means that a participant who has not had a severance from employment would be permitted to make an in-plan Roth rollover from a pre-tax deferral account only if he or she has attained age 59?, died, become disabled, or received a qualified reservist distribution. The plan document must provide for in-plan Roth rollovers, although certain retroactive amendments are permitted as discussed below.

Notably, a plan can add an in-plan Roth rollover option for amounts that are not currently distributable under the terms of the plan but which would be permitted under law. For example, a plan that does not permit in-service withdrawals from pre-tax deferral accounts could add an in-plan Roth rollover option by which participants who reach age 59? could make an in-plan Roth rollover from their pre-tax deferral account - while not otherwise allowing distribution of those amounts. Of course, plans that currently allow in-service withdrawal at age 59? could not be amended to be more restrictive without violating the anti-cutback rule of Code § 411(d)(6).

In terms of participant notices, the guidance makes clear that plans must provide a description of the in-plan Roth rollover feature when a participant or beneficiary receives an eligible rollover distribution. For this purpose, revised language for the Code § 402(f) Safe Harbor Explanation is included in the Notice.

For 401(k) plans, an amendment to add an in-plan Roth rollover feature can be adopted as late as December 31, 2011 (or, if later, the last day of the plan year in which the amendment is effective). For safe-harbor 401(k) plans, the amendment can be adopted as late as December 31, 2011 (or, if later, the time specified in Treasury Regulation § 1.401(k)-3(e)(1), which requires safe harbor plan provisions to be adopted before the first day of the plan year they are effective). For 403(b) plans, an amendment can be adopted as late as the end of the remedial amendment period under Announcement 2009-89 (or, if later, the last day of the plan year in which the amendment is effective). In any case, the amendment must be effective as of the first date the plan operates in accordance with it. The extended amendment period applies to amendments to permit elective deferrals to be designated as Roth contributions, to accept rollover contributions by the designated Roth account, and to allow for in-plan Roth rollovers. It does not apply to the addition of a 401(k) cash or deferred arrangement.

The guidance underscores that, for in-plan Roth rollovers to be eligible for the 2-year income deferral, the distribution must be made no later than December 31, 2010. Also, and perhaps more critically, at the time of the rollover to the Roth account, the plan must have in place a qualified Roth contribution program. According to the Notice, a qualified Roth contribution program is in place on a given date "only if, with respect to compensation that could be deferred beginning with that date, eligible employees are given an opportunity to elect on that date to have designated Roth contributions made to the plan."


Deloitte logoThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact:

Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955.

Copyright 2010, Deloitte.


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