Withholding on Rollovers to Roth IRAs

[Guest PGH.ERISA]

Has anyone seen any definitive IRS guidance on Federal income tax withholding to be made next year in the case of a participant who makes a direct rollover from a qualified plan to a Roth IRA? It seems under Code Section 3405© that it would be necessary to withhold at a mandatory rate of 20% because this would constitute an eligible rollover distribution that is not being rolled over to an eligible retirement plan. Can anyone help?

[Guest esnce3]

I have the same question. Does anyone know?

[masteff]

I looked at Pub 15-A and they haven't released the 2008 version yet. It's one place I'd expect to give some hint. http://www.irs.gov/pub/irs-pdf/p15a.pdf

[Monica Barnard]

As an aside to this topic, what changes will be needed to the Tax Notice to advise participants of the immediate taxation (or not) of distributions rolled into Roth IRAs?

[Guest PGH.ERISA]

I subsequently spoke with three different people at the IRS and they all told me that the current view of the IRS is that no withholding is required. They apparently did not parse the statute like I did, and they seem to feel that all direct rollovers should be treated the same, regarldess of the destination of the rolled over funds.

[Guest mjb]

I subsequently spoke with three different people at the IRS and they all told me that the current view of the IRS is that no withholding is required. They apparently did not parse the statute like I did, and they seem to feel that all direct rollovers should be treated the same, regarldess of the destination of the rolled over funds.

How about providing us with your parsing of the statute which will show that the IRS is wrong. I thought the definition of an eligible retirement plan for which a direct rollover is permitted to a Roth IRA begininng in 2008 was amended to include a rollover from a qualified plan. Otherwise the 10% penalty tax would apply on any amount witheld by the IRS which makes no sense.

[Guest PGH.ERISA]

How about providing us with your parsing of the statute which will show that the IRS is wrong. I thought the definition of an eligible retirement plan for which a direct rollover is permitted to a Roth IRA begininng in 2008 was amended to include a rollover from a qualified plan. Otherwise the 10% penalty tax would apply on any amount witheld by the IRS which makes no sense.

I am not saying the IRS is wrong, merely that it has taken a position that seems to comply with Congressional intent rather than with the precise contours of the IRC. Specifically, Code Section 3405©(2) states that no 20% withholding is required if there is an election under Code Section 401(a)(31)(A) to make a direct transfer to an eligible retirement plan. In turn, Code Section 401(a)(31)(E) states that an eligible retirement plan for purposes of Code Section 401(a)(31)(A) is a plan described in Code Section 402©(8)(B), except that a qualified trust must be a DC plan. Code Section 402©(8)(B) does not provide that a Roth IRA is an eligible retirement plan, except in the case of a designated Roth account under 402A. That limited exception clearly does not pick up most direct rollovers from qualified plans to Roth IRAs, even though such rollovers are now clearly allowed. Thsi failure was the reason fro my original question and my numerous calls to the IRS. I think the failure to change 402©(8) was the result of inadvertence, but I don't know if any technical corrections bill attempts to fix it.

[rosskeene]

I don't think that the definition of "eligible retirement plan" in IRC 402©(8)(B) excludes Roth IRAs. The flush language at the end that subsection merely provides that if Roth funds are rolled over they may only be rolled to a Roth account or Roth IRA. It doesn't say anything about non-Roth funds, which are at issue here. Based on the language of the statute, I would think that no withholding is required. The fly in the ointment is that the legislative history provides that the rules for rollover to a Roth IRA should be the same as the rules for conversion of a traditional IRA to a Roth IRA, which appear to require 10% withholding (subject to election of no withholding after appropriate notice under IRC 3405).

[jevd]

I don't think that the definition of "eligible retirement plan" in IRC 402©(8)(B) excludes Roth IRAs. The flush language at the end that subsection merely provides that if Roth funds are rolled over they may only be rolled to a Roth account or Roth IRA. It doesn't say anything about non-Roth funds, which are at issue here. Based on the language of the statute, I would think that no withholding is required. The fly in the ointment is that the legislative history provides that the rules for rollover to a Roth IRA should be the same as the rules for conversion of a traditional IRA to a Roth IRA, which appear to require 10% withholding (subject to election of no withholding after appropriate notice under IRC 3405).

I Disagree. See 1.402©(2) Q & A 1 & 2 Following.

In particular A 2. States an IRA under 408(a). NOT 408A.

Q-1: What is the rule regarding distributions that may be rolled over to an eligible retirement plan?

A-1: (a) General rule. Under section 402©, as added by UCA, any portion of a distribution from a qualified plan that is an eligible rollover distribution described in section 402©(4) may be rolled over to an eligible retirement plan described in section 402©(8)(B). For purposes of section 402© and this section, a rollover is either a direct rollover as described in §1.401(a)(31)-1, Q&A-3 or a contribution of an eligible rollover distribution to an eligible retirement plan that satisfies the time period requirement in section 402©(3) and Q&A-11 of this section and the designation requirement described in Q&A-13 of this section. See Q&A-2 of this section for the definition of an eligible retirement plan and a qualified plan.

(b) Related Internal Revenue Code provisions --(1) Direct rollover option. Section 401(a)(31), added by UCA, requires qualified plans to provide a distributee of an eligible rollover distribution the option to elect to have the distribution paid directly to an eligible retirement plan in a direct rollover. See §1.401(a)(31)-1 for further guidance concerning this direct rollover option.

(2) Notice requirement. Section 402(f) requires the plan administrator of a qualified plan to provide, within a reasonable time before making an eligible rollover distribution, a written explanation to the distributee of the distributee's right to elect a direct rollover and the withholding consequences of not making that election. The explanation also is required to provide certain other relevant information relating to the taxation of distributions. See §1.402(f)-1 for guidance concerning the written explanation required under section 402(f).

(3) Mandatory income tax withholding. If a distributee of an eligible rollover distribution does not elect to have the eligible rollover distribution paid directly from the plan to an eligible retirement plan in a direct rollover under section 401(a)(31), the eligible rollover distribution is subject to 20-percent income tax withholding under section 3405©. See §31.3405©-1 of this chapter for provisions relating to the withholding requirements applicable to eligible rollover distributions.

(4) Section 403(b) annuities. See §1.403(b)-7(b) for guidance concerning the direct rollover requirements for distributions from annuities described in section 403(b).

© Effective date --(1) Statutory effective date. Section 402©, added by UCA, applies to eligible rollover distributions made on or after January 1, 1993, even if the event giving rise to the distribution occurred on or before January 1, 1993 (e.g. termination of the employee's employment with the employer maintaining the plan before January 1, 1993), and even if the eligible rollover distribution is part of a series of payments that began before January 1, 1993.

(2) Regulatory effective date. This section applies to any distribution made on or after October 19, 1995. For eligible rollover distributions made on or after January 1, 1993 and before October 19, 1995, §1.402©-2T (as it appeared in the April 1, 1995 edition of 26 CFR part 1), applies. However, for any distribution made on or after January 1, 1993 but before October 19, 1995, any or all of the provisions of this section may be substituted for the corresponding provisions of §1.402©-2T, if any.

Q-2: What is an eligible retirement plan and a qualified plan?

A-2: An eligible retirement plan, under section 402©(8)(B), means a qualified plan or an individual retirement plan. For purposes of section 402© and this section, a qualified plan is an employees' trust described in section 401(a) which is exempt from tax under section 501(a) or an annuity plan described in section 403(a). An individual retirement plan is an individual retirement account described in section 408(a) or an individual retirement annuity (other than an endowment contract) described in section 408(b).

[rosskeene]

Ah yes, but, IRC 408A provides that "[e]xcept as provided in this section, a Roth IRA shall be treated for purposes of this title in the same manner as an individual retirement account." Nothing in IRC 408A would exclude a Roth IRA from the definition of "eligible retirement plan" in IRC 402©(8)(B). Furthermore, a Roth IRA would appear to meet the definition of an "individual retirement account" as defined in IRC 408(a). There are six criteria, and none excludes a Roth IRA. If you disagree, how so? Citing the regulations in this case is probematic in any event, as they were issued before PPA's enactment, and are thus superseded to the extent they conflict with the statute.

[jevd]

Ah yes, but, IRC 408A provides that "[e]xcept as provided in this section, a Roth IRA shall be treated for purposes of this title in the same manner as an individual retirement account." Nothing in IRC 408A would exclude a Roth IRA from the definition of "eligible retirement plan" in IRC 402©(8)(B). Furthermore, a Roth IRA would appear to meet the definition of an "individual retirement account" as defined in IRC 408(a). There are six criteria, and none excludes a Roth IRA. If you disagree, how so? Citing the regulations in this case is probematic in any event, as they were issued before PPA's enactment, and are thus superseded to the extent they conflict with the statute.

I agree that PPA would supercede as far as that is concerned but I still find it troublesome that the withholding rules were not ameded as well. I think we need to wait and see if the service rules on this issue. Is it better to interpert that the answer is yes unless it specifically says no or vice-versa???

[rosskeene]

I think it makes sense for plan administrators to use default 10% withholding, subject to election out of withholding with the notice in Section D-26 of Treas. Reg. 35.3405-1T., until the IRS issues more definitive guidance.

[Kimberly S]

But in this business, what makes sense is rarely the correct answer!

[Monica Barnard]

I agree that PPA would supercede as far as that is concerned but I still find it troublesome that the withholding rules were not ameded as well. I think we need to wait and see if the service rules on this issue. Is it better to interpert that the answer is yes unless it specifically says no or vice-versa???

In view of SunGard posting a "Special Tax Notice" with wording addressing rollovers into ROTH IRAs, it appears that this is treated as a rollover so that:

a) the participant is responsible for paying tax (no withholding by plan sponsor)

2) the 10% penalty for distributions prior to age 59 1/2 does not apply

Do ya'll agree?

[masteff]

Okay, the new Pub 15-A didn't give anything but I feel the new Pub 575 gives some indication of the Service's intent....

http://www.irs.gov/pub/irs-pdf/p575.pdf

See page 29, Table 1. In the "Result of a direct rollover" column, for "When to report as income" it notes "However, see Rollovers to Roth IRAs, earlier, for an exception." The Service would not have added this as a note under direct rollover if it intended that rollovers to roths were somehow not included in the general category of "direct rollovers". I feel this clearly shows that the Service does view it as a direct rollover and as such is not subject to withholding.

Oh, and pub 575 does confirm there's no 10% penalty.

[Monica Barnard]

thanks!

[Guest PGH.ERISA]

Notice 2008-30, Q&A-6, issued yesterday, confirms that no withholding is required on a direct rollover to a Roth IRA.