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CCH® PENSION — 04/01/10

Extenders bill would allow for rollover of plan distributions to Roth 401(k) accounts

The American Workers, State and Business Relief Bill of 2010 (H.R. 4213), which would extend through 2010 nearly $30 billion in expired tax provisions (see Pension Plan Guide Newsletter, Report No. 1829, March 22, 2010), would also allow participants in 401(k) plans to roll over distributions to a Roth account maintained under the plan.

Roth rollover restrictions

Participants in 401(k) and other employer-sponsored qualified plans may roll over plan distributions directly to a Roth IRA (thereby avoiding the need for an intervening rollover to a non-Roth IRA followed by a conversion to a Roth IRA). Plan participants are increasingly looking at Roth IRA conversions in 2010 because of special tax rules that defer the generally applicable tax on conversions until 2011 or 2012. However, participants in a traditional 401(k) plan may not roll over distributions to a Roth 401(k) plan and are, thus, forced to take assets out the plan and convert them to a Roth IRA.

Roth 401(k) conversions

The bill would authorize a 401(k) plan to allow plan participants (or surviving spouses) experiencing a distributable event to directly roll over the distribution to a Roth 401(k) account maintained under the 401(k) plan for the benefit of the individual to whom the distribution is made. The provision would effectively keep the participant's money in the plan, thereby potentially reducing "leakage" from the participant's account.

A plan that does not otherwise maintain a designated Roth program may not establish a designated Roth account solely to accept rollover contributions. The distribution to be rolled over to the Roth 401(k) must be otherwise allowed under the plan. Thus, distributions subject to restriction (i.e., in-service distributions and other pre-retirement age distributions) may not be rolled over to the Roth account.

However, a plan may be amended to expand distribution options in order to allow for Roth rollovers. Under such circumstances, the Senate Finance Committee advises, the plan could condition eligibility for the new distribution option on the employee's election to have the distribution directly rolled over to the Roth account.

The amendment would eliminate the need for participants to roll over a plan distribution to a Roth IRA in order to experience the tax benefits of Roth arrangements, including the deferred tax on 2010 conversions. An individual, however, would need to include the distribution in gross income (subject to basis recovery) in the same manner as if the distribution were being rolled into a Roth IRA. Under the special rule applicable to Roth IRA conversions in 2010, the taxpayer would be allowed to include the distributed amount in income in 2011 and 2012. However, note that the "recapture rule" will subject distributions made from the Roth account within 5 years of contribution to the 10% early distribution penalty tax.

The rollover contribution may be implemented at the election of the employee (or surviving spouse) through a direct rollover (operationally through a transfer of assets from the 401(k) plan to the Roth account). However, in order to effect the direct rollover, the employee (or surviving spouse) must be eligible for the distribution (in amount and form) and the distribution must be an eligible rollover distribution.

A plan must be amended (within a prescribed remedial amendment period) in order to allow for the rollover of 401(k) funds to the Roth 401(k). However, a 401(k) plan that includes a Roth program is not required to allow employees (and surviving spouses) to execute the Roth conversion.

CCH Note: The bill would also allow individuals participating in 403(b) plans and state and local government employees participating in 457 plans to treat elective deferrals as Roth contributions.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.

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