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5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.
Final regulations released by the IRS modify existing 401(k) regulations in order to accommodate designated Roth contributions to cash or deferred arrangements, also known as Roth 401(k) plans. Under Code Sec. 402A, added by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), such plans may be offered for the first time this year. Both the newly issued regulations and the regulations they are amending, under Code Sec. 401(k) and Code Sec. 401(m), are effective for plan years beginning on or after January 1, 2006.
Designated Roth contributions, analogous to Roth IRAs, are includable in the employee's gross income at the time the election is made and thus are made with after-tax dollars. When qualified distributions are made at a later date, the contributions and earnings on the contributions are not taxed.
As in the March 2, 2005 proposed version of the regulations ( CCH Pension Plan Guide ¶20,261M ), the final regulations for Roth 401(k) plans require the contributions to be designated irrevocably by the employee as Roth contributions being made in lieu of part or all of the pre-tax elective contributions the employee is otherwise eligible to make under the plan. The employer must include such contributions in the employee’s gross income at the time he would have received the amount had he not made the election to contribute, i.e. as wages subject to applicable withholding requirements, and the plan must maintain the contributions in a separate account.
The final regulations also clarify that a 401(k) plan sponsor may not offer only the Roth contribution option; it must also offer the pre-tax contribution option. The reasoning behind this requirement is that if a cash or deferred arrangement offered only designated Roth contributions, a participant would not be electing to make such contributions in lieu of elective contributions he was otherwise eligible to make under the plan, as required by Code Sec. 402A(b)(1).
The final regulations provide specifics on the separate accounting requirement. Contributions and withdrawals of Roth contributions must be credited and debited to a separate designated Roth account maintained for the employee. In addition, the separate account must be maintained from the time the first designated Roth contribution is made until the point when the entire account has been completely distributed. Gains, losses, credits and charges must be separately allocated on a reasonable and consistent basis to the designated Roth account and other accounts under the plan.
A designated Roth account may not contain contributions other than designated Roth contributions and rollover contributions described in Code Sec. 402A(c)(3)(B). Neither forfeitures nor matching contributions may be allocated to a designated Roth account.
Under the final regs, designated Roth contributions must satisfy the requirements applicable to any other elective contributions made under qualified cash or deferred arrangements. Roth contributions are subject to the nonforfeitability and distribution restrictions applicable to elective contributions. They may also be treated as catch-up contributions and serve as the basis for participant loans.
Plans that provide for both pre-tax elective contributions and designated Roth contributions are permitted by the regulations to provide for automatic enrollment; that is, where contributions are made in the absence of an affirmative election. However, the plan must set forth the extent to which default contributions are pre-tax elective contributions or designated Roth contributions. To the extent that default contributions are designated Roth contributions, the employee is deemed to have irrevocably made such an election for the contribution, despite the absence of an affirmative election.
The regulations treat designated Roth contributions as employer contributions and as elective contributions for purposes of the ADP nondiscrimination test. The rules allow for a correction procedure that a plan could use if it fails to satisfy the ADP test for a year. Under an amendment to the ADP testing rules in Reg. §1.401(k)-2, a plan may permit a highly compensated employee (HCE) with elective contributions for a year that includes both pre-tax elective contributions and designated Roth contributions to elect whether the excess contributions are to be attributed to pre-tax elective contributions or designated Roth contributions.
Employee contributions and employer contributions to a 401(k) plan must satisfy the ACP test. The ACP test is similar to the ADP test, except that it tests employee contributions and employer matching contributions, rather than elective contributions. Under an amendment to the ACP testing rules in Reg. §1.401(m)2), a corrective distribution of excess contributions is not includible in gross income to the extent it represents a distribution of designated Roth contributions. However, the income allocable to a corrective distribution of excess contributions that are designated Roth contributions is includible in gross income in the same manner as income allocable to a corrective distribution of excess aggregate contributions that are pre-tax elective contributions.
The regulations clarify that a direct rollover from a Roth 401(k) may only be made to another designated Roth account under an applicable retirement plan under Code Sec. 402A(e)(1) or to a Roth IRA under Code Sec. 408A, and only to the extent the direct rollover is permitted under the rules of Code Sec. 402(c).
These regulations do not provide guidance as to the application of the EGTRRA sunset provision. If the current sunset provision remains unaltered, its provisions, including Code Sec. 402A which authorizes Roth 401(k)s, will expire after December 31, 2010. While the IRS has not indicated that guidance regarding the sunset provision is forthcoming, it has stated that additional regulations are forthcoming on the tax treatment of distributions of designated Roth contributions.
For more information on this and related topics, consult the CCH Pension Plan Guide.
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