Designated Roth contributions (a/k/a Roth 401(k) or Roth
deferrals) have been available since 2006, but a change in the tax
laws governing Roth IRAs has reenergized discussions about this
feature. This article is in Q&A format and addresses some of the
more common questions about Roth 401(k) contributions. But first, a
Traditional deferrals reduce a participant's income for federal
and, in most cases, state tax purposes at the time of contribution.
Those amounts grow on a tax-deferred basis until the participant
takes a distribution, which is taxable as ordinary income. Roth
deferrals are fully taxable to the participant at the time of
contribution. However, if certain requirements are met, so-called
"qualified distributions" of Roth deferrals and the earnings thereon
are completely tax free.
Apart from the tax differences, Roth deferrals are treated the
same as traditional deferrals for all plan purposes. The normal
limits and non-discrimination requirements apply. Roth deferrals are
also subject to the same withdrawal restrictions, i.e. death,
disability, retirement, financial hardship, etc.
What types of plans can allow Roth deferrals?
Both 401(k) and 403(b) plans can include a Roth component.
Are there any income restrictions preventing higher wage earners
from making Roth 401(k) contributions?
No. Unlike Roth IRAs, any employee eligible for the plan can make
Roth deferrals regardless of income.
What are the limits on the amount of Roth deferrals a
participant can contribute?
The salary deferral limit is $16,500 for 2010. Roth and pre-tax
deferrals are added together for purposes of this limit.
Can catch-up contributions be designated as Roth deferrals?
Yes. Catch-up contributions merely represent an increase in the
regular deferral limit for those who are catch-up eligible.
What is all the buzz about Roth conversions in 2010?
Prior to 2010, those above a certain income threshold (generally
$120,000 for individuals and $176,000 for married couples) were not
permitted to make Roth IRA contributions. Starting this year, that
income cap is removed for those who wish to convert non-Roth IRAs
into Roth IRA accounts. The amounts converted must be included in
taxable income; however, those who convert during 2010 have the
option to spread that tax liability equally over two years.
Can a participant elect to convert pre-tax 401(k) deferrals into
Roth 401(k) deferrals?
No. The regulations make it very clear that when a participant
elects to make pre-tax deferrals, that election is irrevocable.
While the participant may change how future contributions are
designated, existing contributions cannot be converted within the
plan. However, there has been discussion on Capitol Hill about
changing the law to allow conversions inside the 401(k) plan similar
to the IRA conversions that are allowed beginning in 2010.
Can Roth 401(k) accounts be directly rolled over into another
401(k) plan or a Roth IRA?
Yes. Roth accounts from a qualified plan or 403(b) plan can be
rolled into another qualified plan or 403(b) plan that allows Roth
contributions. These amounts can also be rolled into a Roth IRA.
Can a Roth IRA be rolled over into a Roth 401(k) or 403(b)?
No. Roth IRAs can only be rolled into other Roth IRAs.
What are the requirements that must be satisfied to receive a
tax-free distribution from a Roth account?
A participant must complete a so-called five-year period and the
distribution must occur on or after attainment of age 59½, death or
disability. A tax-free Roth distribution is referred to as a
What is the five-year period and when does it start?
The five-year period is generally a holding period a participant
must satisfy to take a qualified distribution. It begins on the
first day of the first taxable year in which a participant first
makes Roth deferrals to the plan. For example, if a participant
makes his first Roth deferral on October 1, 2010, the five-year
period starts on January 1, 2010.
Is the plan sponsor or the participant responsible for tracking
the five-year period?
Plan sponsors and their service providers are required to track
the Roth five-year period as well as the amount of basis for each
participant. This requirement is likely to present significant
record-keeping challenges, especially in takeover situations.
Does the five-year period start over when a participant goes to
work for another company and makes Roth deferrals into his new
It depends. If the participant rolls over his Roth account to the
new plan, the portion of the five-year period already satisfied is
transferred to the new plan. However, if the participant does not
roll over the Roth account, his five-year period starts over with
respect to contributions to the new plan.
Is there any coordination between the Roth 401(k) and Roth IRA
No. The two five-year periods are determined independently of one
another. Thus, a rollover of a Roth deferral account into a Roth IRA
requires the five-year period to be redetermined.
What happens if a participant takes a loan from the Roth account
and then defaults, requiring deemed distribution of the outstanding
A deemed distribution of a participant loan is never treated as a
qualified distribution even if it occurs after the participant has
satisfied the five-year period and attained age 59½, died or become
disabled. Therefore, the portion of the deemed distribution
attributable to Roth is subject to income tax. To avoid confusion in
this area, the loan policy can be written to restrict participant
loans to non-Roth accounts.
Do Roth deferrals affect ADP testing?
Yes. Roth deferrals are included with pre-tax deferrals for
purposes of the ADP test. However, since Roth deferrals are not
tax-deductible, lower-paid participants may be unable to defer at
the same level as with pre-tax deferrals.
Example: Marge earns $50,000 and
has $5,000 available to save for retirement. She is in a combined
25% tax bracket. If Marge makes pre-tax deferrals, she can
contribute the full $5,000 to the plan. However, if Marge makes Roth
deferrals, she must pay $1,250 (25% of $5,000) in taxes, leaving her
with only $3,750 to contribute to the plan. Since Marge is a
non-highly compensated employee, her lower deferral percentage would
have a negative impact on the ADP test.
|Annual Salary: $50,000
Total Available for Savings: $5,000
|Income Tax (25%)
Employers may want to consider a safe-harbor 401(k) plan if they
are likely to experience this situation.
Can availability of Roth deferrals be restricted to those whose
incomes are high enough to maximize their contributions?
No. The availability of Roth deferrals is subject to the minimum
coverage rules for 401(k) plans and the universal availability rules
for 403(b) plans.
Are Roth deferrals considered when calculating the employer
Unless plan terms specify otherwise, pre-tax and Roth deferrals
are both considered in the employer match calculation. Matching
contributions are always treated as tax-deferred regardless of
whether Roth deferrals are used in the calculation.
Are Roth deferrals subject to Required Minimum Distributions?
Yes. The regulations specifically provide that Roth deferrals are
subject to the required minimum distribution rules. This is in
contrast to Roth IRAs which do not require minimum distributions. It
appears that a participant may avoid required minimum distributions
on Roth deferrals by rolling over these amounts to a Roth IRA prior
to the attainment of age 70½.
Do the automatic IRA rollover rules apply to Roth deferrals?
No. Roth and pre-tax accounts are considered separately for
purposes of the automatic rollover rules. Therefore, to the extent
the Roth and/or pre-tax portion of a participant's account is less
than $1,000, it is not required to be automatically rolled over even
though the combined vested account balance may exceed $1,000.
Can a plan that does not otherwise allow Roth contributions
accept a Roth rollover?
No. Regulations clearly state that a designated Roth account can
only be rolled over into another 401(k) or 403(b) plan that has a
designated Roth program.
Is the employer required to report any information at the time
Roth deferrals are contributed to the plan?
Yes. Employers must report Roth deferrals in box 12 of Form W-2
with code AA for 401(k) plans and BB for 403(b) plans.
How are Roth distributions reported on Form 1099-R?
Roth distributions must be reported on a separate Form 1099-R
using Code B. The non-taxable basis is reported in Box 5, and the
beginning of the five-year period is reported in an unnumbered box
next to Box 10.
Are there any reporting requirements for a participant who
elects Roth deferrals?
No. The participant is not required to report any additional
information with respect to Roth 401(k) or 403(b) contributions.
However, a participant rolling over a Roth deferral account into a
Roth IRA must keep track of the rollover amounts and the five-year
period with respect to the IRA.
Which is better for participants — Roth or pre-tax deferrals?
The answer to this question depends on each individual's
financial situation and is beyond the scope of this article. Factors
such as current and future tax brackets, estate planning needs and
more will impact the decision, so participants should consult their
tax and/or legal advisors for assistance in reviewing all of the
relevant facts and circumstances.
While Roth IRAs are enjoying significant publicity due to the
change in the conversion rules, it is interesting to note that there
has not been significant implementation of the feature in 401(k)
plans. According to the Profit Sharing/401(k) Council of America's
52nd Annual Survey, 36.7% of plans allowed Roth contributions in
2008; however, only 15.6% of participants that had the Roth option
available elected to take advantage of it.
Plan sponsors who are considering Roth 401(k) deferrals should
consult with their advisors and service providers to review the
potential advantages and disadvantages that the Roth feature