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Rules for Making Roth IRA Rollover in a 401(k) Qualified Plan

On November 26, 2010, the IRS issued Notice 2010-84 containing guidance for 401(k) and 403(b) plans about in-plan Roth rollovers – a feature that permits plan participants to roll over eligible rollover distributions (ERDs) made after September 27, 2010, from a non-Roth account into a designated Roth account in the same plan. A non-Roth account means any plan account that does not hold designated Roth contributions.

Eligible Participants

  • Besides plan participants, surviving spouse beneficiaries and alternate payees who are current or former spouses are also eligible to do an in-plan Roth rollover.

Types of In-plan Roth Rollovers

  • In-plan Roth direct rollover – when the plan trustee transfers an eligible rollover distribution from a participant’s non-Roth account to the participant’s designated Roth account in the same plan.
  • In-plan Roth 60-day rollover – when the participant deposits an eligible rollover distribution within 60 days of receiving it from a non-Roth account into a designated Roth account in the same plan.

Plan Amendments

  • 401(k) and 403(b) plans have extended deadlines to amend to allow 2010 in-plan Roth rollovers if the amendment’s effective date is the date the plan first operated in accordance with that amendment.
    • 401(k) plans have until the later of the last day of the year in which the amendment is effective or December 31, 2011.
    • Safe harbor 401(k) plans have until the later of the day before the first day of the plan year in which the safe harbor plan provisions are effective or December 31, 2011.
    • 403(b) plans have until the later of the plan’s remedial amendment period (described in Announcement 2009-89) or the last day of the first plan year in which the amendment is effective.
  • A §457(b) government plan may adopt an amendment to include a designated Roth account after December 31, 2010, and then allow in-plan Roth rollovers.

Eligible Rollover Distributions

  • Participants may only roll over eligible rollover distributions from a non-Roth account to a designated Roth account in the same plan.
  • A plan can be amended to allow new in-service distributions from the plan’s non-Roth accounts conditioned on the participant rolling over the distribution in an in-plan Roth direct rollover. However, the plan cannot impose this condition on any existing distribution options available under the plan.

In-Plan Roth Rollover Account

  • A plan may have to hold in-plan Roth rollovers for a participant in a separate account maintained solely for these rolled over amounts.

In-Plan Roth Rollovers Not Treated as a Distribution

  • A distribution rolled over as an in-plan Roth direct rollover is not treated as a distribution for the following purposes:
    • Transferring a plan loan to the designated Roth account without changing its repayment schedule;
    • Requiring spousal consent;
    • Requiring a participant’s consent before an immediate distribution of an accrued benefit of more than $5,000; and
    • Eliminating a participant’s right to optional forms of benefit.

Written Explanation (402(f) Notice)

If a plan offers in-plan Roth rollovers, it must include a description of this feature in the written explanation (402(f) Notice) the plan provides to participants who receive an eligible rollover distribution. Notice 2010-84 describes how a plan that uses the safe harbor explanations can revise them if it offers an in-plan Roth rollover option to participants.

Taxability and Withholding

  • In-plan Roth rollovers are not subject to the 10% additional tax on early distributions under Code §72(t) and an in-plan Roth direct rollover is not subject to the mandatory 20% withholding under Code §3405(c). An individual who makes an in-plan Roth direct rollover may have to increase his or her federal income tax withholding or make estimated tax payments to avoid an underpayment of tax penalty.
  • A special recapture rule applies when a plan distributes any part of the in-plan Roth rollover within a 5-taxable-year period, making the distribution subject to the 10% additional tax on early distributions under Code §72(t) unless an exception to this tax applies or the distribution is allocable to any nontaxable portion of the in-plan Roth rollover. The 5-taxable-year period begins January 1 of the year of the in-plan Roth rollover and ends on the last day of the fifth year of that period. This special recapture rule does not apply when the participant rolls over the distribution to another designated Roth account or to his or her Roth IRA but does apply to a subsequent distribution from the rolled over account or IRA within the 5-taxable-year period.
  • Notice 2010-84 prescribes an ordering rule and an example involving a distribution from a participant’s designated Roth account to which the participant had made an in-plan Roth rollover.

Special Rules for 2010 In-Plan Roth Rollovers

  • The participant generally reports the taxable amount (fair market value of the distribution minus the employee’s basis in the distribution) of an in-plan Roth rollover in the taxable year in which he or she receives the distribution. However, for in-plan Roth rollovers done in 2010, the participant:
    • reports half of the taxable amount in 2011 and the other half in 2012 (2-year income spread), or
    • elects to report the entire taxable amount in 2010.

If a participant elects to include the taxable amount in 2010, this election applies to all of his or her in-plan Roth rollovers in 2010 and he or she may not revoke the election after the due date (including extensions) of his or her 2010 tax return.

  • In order for a participant to be eligible for the 2-year income spread, the distribution to be rolled over in an in-plan Roth rollover has to be made no later than December 31, 2010, and the plan must have a designated Roth account in place at the time the distribution is rolled over.
  • Special income acceleration rules apply if the participant later receives a distribution of any amount of the taxable portion of the in-plan Roth rollover in 2010 or 2011 that wouldn’t have been included in gross income until 2011 and 2012. Under these rules, the participant must increase gross income in the year of distribution by the amount of the distribution that the participant could have deferred to 2012. Notice 2010-84 has an example where a participant receives a distribution allocable to the taxable portion of an in-plan Roth rollover where such taxable portion has not yet been included in the participant’s gross income.

No Re-characterization Rights

  • Unlike a conversion or rollover to a Roth IRA, a participant may not re-characterize any amount of an in-plan Roth rollover.

Loans

  • If an outstanding loan is part of in an in-plan Roth rollover, the taxable amount of the rollover is the balance of the loan.

Reporting 2010 In-plan Roth Rollovers

Form 1099-R Reporting

  • Report 401(k) and 403(b) in-plan Roth direct rollovers on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.:
  • Include the amount rolled over in box 1 (Gross distribution)
  • Include the taxable amount rolled over in box 2a (Taxable amount)
  • Don’t check box 2b (Taxable amount not determined)
  • Report the basis in the amount rolled over in box 5 (Employee contributions)
  • Use distribution code “G” in box 7

Plans are not required to withhold 20% for an in-plan Roth direct rollover. The 10% additional tax on early distributions under Code §72(t) does not apply to any amount of an in-plan Roth rollover.

Plans must report any distributions made in 2010 from designated Roth accounts allocable to an in-plan Roth rollover on a separate Form 1099-R. Report the distribution as you would any other distribution from a designated Roth account (see Form 1099-R instructions). However, in the blank box to the left of box 10, enter the amount of the distribution allocable to the in-plan Roth rollover.

For additional information, please see the Changes to Current Tax Forms, Instructions, and Publications Web page.

Plan Participants – Form 8606 Reporting

Plan participants who make an in-plan Roth rollover in 2010 must:

  • File Form 8606, Nondeductible IRAs, with their 2010 tax return
  • Complete Form 8606, Part III, to report their in-plan Roth rollover
  • Complete certain lines of Form 8606, Part IV, if they receive a distribution in 2010 of any amount of their in-plan Roth rollover
  • Complete Form 8606, Part II, to report any amount converted from a non-Roth IRA to a Roth IRA in 2010
  • File and complete a separate Form 8606, Part III, if they also rolled over amounts from a qualified retirement plan to a Roth IRA in 2010
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