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Allocation between Roth and non-Roth amounts when participant receives partial distribution from plan


Luke Bailey

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Some 401(k) plans have many different types of distributions besides lump sum on termination of employment, e.g. hardship, non-hardship in-service after attainment of age 59-1/2, in-service at any age from rollover account, partial distributions after separation from employment, and RMDs. If the plan also has Roth elective deferrals and an in-plan Roth rollover feature, an employee's accounts for elective deferrals, nonelective, matching, and rollover may all contain both Roth and non-Roth accumulations. So when a distribution of less than 100% of any account is made, you have to determine the portion that is Roth, and the portion that is not Roth.

The 401(k) LRMs allow a plan to provide that distributions of excess contributions after failure of ADP test are made first from non-Roth amounts, but aside from that, I can find no guidance from IRS regarding what it thinks is permissible and have come to conclusion that it is up to the plan and that the plan can also let the participant decide in his/her distribution request form. E.g., plan document could permit a participant who qualifies for an age 59-1/2 non-hardship in-service distribution, who wants to receive $50k as distribution, and who has $100k of Roth and $100k of non-Roth spread over elective deferral, matching, and nonelective accounts to elect to take the entire $50k from the non-Roth. Also, plan could provide that RMDs always came first from non-Roth until non-Roth exhausted. Anyone else given this some thought or found guidance on the question that I am unaware of?

One major vendor has a distribution form that seems to permit what I describe in prior paragraph (i.e., employee choice), but I did not find a supporting provision in its volume submitter.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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Typically, the differentiation between distribution availability upon sources will be outlined in the adoption agreement. For instance, ER Match may have a different distribution availability than ER Nonelective; and you can typically always withdraw from Rollover if nothing else.

I imagine your question centers around the Deferral Source actually consisting of two distinct types of money: Roth Deferrals and Pre-tax Deferrals.  To me, when an adoption agreement says : A Participant may withdraw all or any portion of his/her vested Account Balance, to the extent designated, upon the occurrence of any of the event(s) selected under this... 

that seems to open the door for the participant to actually designate the source and promotes total flexibility. 

Good Luck!

CPC, QPA, QKA, TGPC, ERPA

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The default provision in our VS document is that the participant can designate which portion of a distribution from his/her salary deferral accounts is Roth and which portion is pre-tax.  The adoption agreement allows you to override that and select either pro-rata, Roth first or pre-tax first. 

 

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My VS document provides that the Plan Admin can determine the ordering rule as long as it is nondiscriminatory, and that such determination may be to allow the participant to select the order.  Like @Kevin C, we can also override that in the AA and/or limit certain types of distributions to certain fund sources.

 

 

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Maybe not enough coffee yet today, but I'm confused by this:

"If the plan also has Roth elective deferrals and an in-plan Roth rollover feature, an employee's accounts for elective deferrals, nonelective, matching, and rollover may all contain both Roth and non-Roth accumulations."

Designated Roth accounts are by definition separate accounts under the plan. So I agree with you and Kevin C that the plan can specify the order in which the accounts are reached, or can allow the participant to choose. For example, the IRS has specifically stated that where hardship distributions are allowed, a participant can elect to receive a hardship distribution from his/her designated Roth account (presumably, unless the plan provides otherwise)"

"Since I make designated Roth contributions from after-tax income, can I make tax-free withdrawals from my designated Roth account at any time?

No, the same restrictions on withdrawals that apply to pre-tax elective contributions also apply to designated Roth contributions. If your plan permits distributions from accounts because of hardship, you may choose to receive a hardship distribution from your designated Roth account. The hardship distribution will consist of a pro-rata share of earnings and basis and the earnings portion will be included in gross income unless you have had the designated Roth account for 5 years and are either disabled or over age 59 ½."

https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts

 

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I appreciate all the input, which are consistent with what I thought was probably accepted practice. Seems correct to me, although odd that there is no guidance from IRS really on the issues, other than some inferences that can be drawn from subregulatory guidance, e.g. the FAQ noted by card above. 

Re the "designated Roth account" concept, it seems to me that it's less an account and more a "tag," since the Roth money in the "designated Roth account" retains the characteristics of the account from which it originated. So if I do an in-plan Roth rollover of amounts from my pre-tax elective deferral account, that money goes into my "designated Roth account," but it retains the distribution rules of its source. Ditto for other source accounts. Or you could look at it the other way around, i.e., all the portions of the designated Roth account are "tagged" with the distribution. Either way, there is in essence an overlap between the designated Roth account and the accounts in which the money originates.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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It does get complex, because you're simultaneously balancing several principles; taxation vs distribution availability.  Merely changing the taxation doesn't change the withdrawal availability; or vice versa.  One consistent underlying principle you'd typically want to maintain is that the participant should have the flexibility determine the desired taxable outcome with respect to the distribution being taken.  Some individuals may want to take the taxation in the current year (e.g. withdrawal from pretax) due to low taxable income for that year.  Others may want to take an available distribution from a Roth source to avoid as much taxation as possible for that withdrawal.  

So, it's only an additional designation by the participant.

Good Luck!

CPC, QPA, QKA, TGPC, ERPA

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