ROTH deferrals and ROTH conversions

[Basically]

Simple questions for a cheat sheet I am making....

• If a participant makes ROTH deferrals, that money has its own 5 year clock... Yes?
• If a participant continues each year to make ROTH deferrals, does that new money use the original clock start date?
• If a participant makes an in-plan ROTH conversion, I know that has its own start date.  And every time they do an in-plan ROTH conversion the conversion gets its own start date.  
  Here are the questions...  all in-Plan ROTH conversions need to be in their own investment account... That account can be on paper... correct?  My system will track it, that's all that matters, correct?

Thanks

[Lou S.]

A participant has "one" clock for their ROTH deferrals per plan, it starts with the first contribution year. There is no class year counting of ROTH 401(k) contributions for the 5 year clock, once you've satisfied the 5-year period, the participant is good for that particular 401(k) plan. That is if you are 59.5 and your first contribution year was 5 for more years ago, your distributions would be qualified ROTH distributions.

Subsequently each in-plan ROTH conversion has it's own 5 year clock. As long as you can track it on paper and can report it for taxes, you are fine.

Lastly I am not sure how the clock works with respect to SECURE employer contributions that a participant elects to have deposited as ROTH, should the plan allow for that. I'm guessing it is addressed somewhere or in future guidance on SECURE 2.0 but I'm not 100% sure on that.

[Basically]

Thank you.  That's a big help.

[WCC]

On 10/10/2024 at 10:11 AM, Basically said:

If a participant makes an in-plan ROTH conversion, I know that has its own start date.  And every time they do an in-plan ROTH conversion the conversion gets its own start date.  

Just trying to learn here for my own knowledge, but is this above statement correct? IRS notice Q&A-8 of Notice 2013-74 talks about the 5-year clock, but does this mean it starts over with every conversion? I was under the impression there was only one 5 year clock per participant in the plan, but maybe I am wrong. I could not find anything directly on point in the EOB. If someone were converting after-tax to Roth immediately every period, or converting PS dollars every year to Roth, they would have a new 5-year clock with every conversion? Curious of your thoughts.

[Lou S.]

1 hour ago, WCC said:

Just trying to learn here for my own knowledge, but is this above statement correct? IRS notice Q&A-8 of Notice 2013-74 talks about the 5-year clock, but does this mean it starts over with every conversion? I was under the impression there was only one 5 year clock per participant in the plan, but maybe I am wrong. I could not find anything directly on point in the EOB. If someone were converting after-tax to Roth immediately every period, or converting PS dollars every year to Roth, they would have a new 5-year clock with every conversion? Curious of your thoughts.

That is a good point. I do know for a fact that each IRA conversion to ROTH has its own 5 year conversion period and maybe I projected that incorrectly back to ROTH 401(K) Plan conversions. But can't put my finger on an in plan citation so I could be wrong on that piece.

[G8Rs]

Part of the confusion might be that there are two different 5 year rules. 

The one used to determine if there is qualified Roth distribution is one clock per Roth account, even if the Roth account has separate sub-accounting (which is one of your Qs: it’s just an accounting). The clock starts with the first deferrals, in-plan Roth rollover or designated Roth employer contribution. Whichever is first starts the clock for determining if the earnings can be distributed tax-free. Separate accounting is used to determine when an amount can be distributed. For example, Roth deferrals generally can’t be distributed prior to 59 1/2 but an in-plan rollover might be distributable sooner, depending on the plan and the source of the rollover. 
 

The second 5 year rule is an anti-abuse rule relating to the 10% early tax. It’s referred to as a recapture rule. The rule only applies to in-plan Roth rollovers. Normally the 10% tax is based on the amount includible in income. Roth is after-tax so the 10% tax would only apply to earnings, if it’s not a qualified distribution. But suppose I have a pre-tax account, I want an early distribution and don’t want to owe the penalty tax. I do a Roth rollover and pay normal taxes. At a later date, I then take a distribution from that account. I don’t owe the 10% penalty on the basis. Or maybe I do. Congress plugged the possible abuse by imposing the 10% penalty on the basis if the rollover was done within a 5 year period prior to the distribution. For that rule, each in-plan Roth rollover has its own 5 year period.  2010-84 Q&A 12. 

I don’t see anything in SECURE 2.0 indicating that the recapture rule applies to Roth employer contributions.