On December 11, 2013, the Internal Revenue Service (“IRS”) issued containing additional guidance on rollovers within a retirement plan to designated Roth accounts within the same plan (“in-plan Roth rollovers”). Depending upon an individual’s circumstances, an in-plan Roth rollover can provide powerful long-term tax benefits by allowing employees to convert their current, pre-tax 401(k) plan account balance to a Roth 401(k) without taking a distribution from their employer’s plan. By doing so, an individual would accelerate payment of federal taxes that would otherwise be paid upon receiving distributions at retirement, but allow future account earnings to accumulate on a tax-free basis with all subsequent plan distributions being tax-free.
The highly anticipated release of this Notice represents an expansion to the in-plan Roth rollover opportunity previously provided under the Small Business Jobs Protection Act of 2010 (“SBJA”), IRS Notice 2010-84, and the American Taxpayer Relief Act of 2012 (“ATRA”). In summary, SBJA permitted individuals who are participants in a qualified retirement plan to perform an in-plan Roth rollover only where the account balance was otherwise eligible for distribution (i.e., the participant had experienced a severance from employment, attained age 59½, or had become disabled, among other less-common distributable events), with additional guidance provided under IRS Notice 2010-84.
Subsequently, ATRA expanded on the rules set forth under SBJA by allowing individuals in qualified retirement plans to do an in-plan Roth rollover without incurring a distributable event. While ATRA loosened the restrictions on in-plan Roth rollovers, it left many questions unanswered regarding its application and the resulting federal income tax considerations.
IRS Notice 2013-74 provides the following clarifications:
- In order to be eligible for an in-plan Roth rollover, the amount must be fully vested.
- Any amount rolled over (including earnings) will remain subject to the distribution restrictions that were applicable before the amount was rolled over. In other words, if an actively employed participant makes an in-plan Roth rollover of his pre-tax elective deferral account, that amount may not be distributed until he attains age 59½. The application of this requirement effectively requires retirement plans to account for in-plan Roth rollover balances separately from all other account balances (pre-tax elective deferrals, other Roth contribution balances, etc.).
- Federal income tax withholding, whether mandatory or voluntary, does NOT apply. As such, an employee may need to make estimated tax payments or increase federal tax withholding in order to avoid an underpayment penalty.
- Plans allowing in-plan Roth rollovers at any time during 2014 will be permitted to adopt the appropriate plan amendment(s) by December 31, 2014.
- If the in-plan Roth rollover is the first contribution made to an employee’s Roth account, the 5-taxable-year period necessary for a “qualified distribution” begins on the first day of the taxable year in which the rollover is performed.
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