5500 Preparer's Manual for 2012 Plan Years
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The IRS has issued detailed guidance clarifying many of the outstanding issues surrounding in-plan Roth 401(k) rollovers in IRS Notice 2010-84.
The Small Business Jobs Act of 2010 (P.L. 110-240), effective for distributions made after September 27, 2010, authorized plans that include a Roth contribution program to allow individuals to roll over amounts from accounts (other than the designated Roth account) to the Roth account. The IRS has issued guidance on its website regarding the 1099-R reporting of in-plan rollovers, the types of distributions eligible for rollover, and other issues (see CCH Pension Plan Guide Newsletter, Report No. 1865, December 6, 2010). However, practitioners were uncertain of the tax rules applicable to in-plan Roth rollovers and the time frame in which a plan needed to be amended to allow for rollovers in 2010. In the newly issued formal guidance, the IRS illustrates the applicable tax treatment of rollovers and subsequent distributions from Roth accounts and provides for retroactive plan amendments implementing the rollovers.
Retroactive plan amendments authorized
A plan amendment providing for in-plan Roth rollovers is a discretionary amendment that generally must be adopted by the last day of the plan year in which the amendment is effective. However, in order to enable plan participants to make in-plan Roth rollovers before the end of the 2010 plan year, the IRS is extending the deadline for adopting plan amendments (including amendments to provide for in-plan Roth rollovers in a 401(k) plan) to the later of the last day of the plan year in which the amendment is effective or December 31, 2010. Thus, a plan may be amended retroactively to allow for in-plan Roth rollovers. However, amendments must be effective as of the date the plan first operates in accordance with the amendment.
CCH Note: The IRS cautions that the extension does not apply to a plan amendment that is adopted to add a 401(k) cash or deferred arrangement to the plan.
Safe harbor 401(k) plans. The extended time by which a plan may adopt amendments authorizing in-plan Roth rollovers also applies to safe harbor 401(k) plans. However, the amendment of the safe harbor 40(k) plan must be made by the later of the day before the first day of the plan year in which the safe harbor provisions are effective (rather than the last day of the plan year in which the amendment is effective) or December 31, 2011.
In-plan rollover of amounts not distributable under the plan
The in-plan Roth 401(k) rollover option is restricted to eligible rollover distributions. However, the IRS will allow a plan to add an in-plan Roth direct rollover option for amounts that are permitted to be distributed under the Internal Revenue Code, but that are not distributable under plan terms. In addition, the plan would not be required, by implementing the amendment, to allow for any other rollover or distribution option for the amounts. Thus, the IRS explains, a plan that does not currently allow for in-service distributions from a participant's pre-tax elective deferral account may be amended to permit in-plan Roth direct rollovers from the account by participants who have attained age 59 1/2, while not otherwise permitting distribution of the funds. However, the IRS cautions that a plan may not impose such a restriction on a pre-existing distribution option without violating Code Sec. 411(d)(6).
Qualified Roth contribution program in place
A plan must have a qualified Roth contribution program in place at the time a rollover contribution to a designated Roth account is made in an in-plan Roth rollover. The IRS further advises that, although a plan may be amended retroactively to add a qualified Roth contribution program, a program will be "in place" on a date only if, with respect to compensation that could be deferred beginning with that date, eligible employees are allowed the opportunity to elect on that date to have designated Roth contributions made to the plan.
Written explanation (402(f) rollover notice) of in-plan Roth rollover option
A plan that offers in-plan Roth rollovers must include a description of this feature in the written explanation (402(f) Notice) that the plan furnishes to participants who receive an eligible rollover distribution. The IRS has produced two safe harbor explanations that may be provided to individuals receiving an eligible rollover distribution that highlights the tax consequences of the rollover and subsequent distributions from the Roth account.
In-plan Roth rollover by alternate payee
An in-plan Roth rollover may be executed by an alternate payee only if he or she is the spouse or former spouse of the plan participant. This restriction extends from the fact that in-plan Roth rollovers are limited to eligible rollover distributions. Eligible rollover distributions may be made to a spousal beneficiary and to an alternate payee who is a spouse or former spouse, but not a nonspousal beneficiary.
CCH Note: Code Sec. 402(c)(11), which allows for nonspousal beneficiary rollovers to an IRA or Roth IRA, does not, the IRS stresses, allow for rollovers to qualified plans.
Tax and withholding rules
The taxable amount of an in-plan Roth rollover is included in a participant's gross income. The taxable amount is the fair market value of the distribution reduced by any basis the participant has in the distribution. Accordingly, the IRS explains, the fair market value of a distribution that includes employer securities must reflect net unrealized appreciation. In addition, the IRS notes, if an outstanding loan is rolled over in the in-plan Roth rollover, the balance of the loan is included in gross income.
20% withholding does not apply. In-plan Roth rollovers are not subject to the 10% early withdrawal penalty tax. Nor will mandatory 20% withholding apply to in-plan Roth direct rollovers. However, the IRS cautions that a participant electing an in-plan Roth rollover may need to increase withholding or make estimated tax payments to avoid an underpayment penalty.
Year in which distribution included in income. The taxable amount of a distribution that is rolled over in an in-plan Roth rollover is generally included in gross income in the tax year in which the distribution occurs. However, an individual may elect to include the taxable amount of an in-plan Roth rollover made in 2010 in equal parts in 2011 and 2012.
CCH Note: A plan may not be eligible for the 2-year income deferral unless the distribution is made by December 31, 2010 and the plan has a designated Roth account in place at the time the distribution is rolled over.
An employee may elect to include the entire taxable amount of the 2010 rollover in 2010 gross income. However, the IRS stresses that a participant who elects to include the rolled over amounts in 2010 gross income may not revoke that election after the due date (including extensions) of the 2010 federal income tax return.
CCH Note: Similarly, a participant who has elected an in-plan Roth rollover may not undo or recharacterize the in-plan Roth rollover. The recharacterization rule of Code Sec. 408A(d)(6), the IRS advises, applies only to IRA contributions.
Income acceleration of distribution allocable to 2010 in-plan Roth rollovers. Special income allocation rules apply when a participant receives a distribution of any amount of the taxable portion of the in-plan Roth rollover in 2010 or 2011 that would not have been included in gross income until 2011 and 2012. Under such circumstances, the participant's gross income for the year of the distribution will be increased by the amount of the distribution that would not otherwise be includible in gross income until a later year. However, the amount that would otherwise be includible in the participant's gross income in 2012 would be reduced by the income accelerated. Similarly, if a distribution is made in 2010, the amount that would otherwise be includible in the participant's gross income in 2011 is reduced by the amount that the income accelerated to 2010 exceeds the amount that would otherwise be includible in income in 2012.
Recapture rule for Roth distributions within 5 years. In the event an amount allocable to the taxable amount of an in-plan Roth rollover is distributed within the 5-year taxable period beginning with the first day of the participant's taxable year in which the rollover was made, the distribution will be subject to the 10 percent penalty tax assessed on early distributions under Code Sec. 72(t).
The 5-year recapture rule will not apply to a distribution that is rolled over to another designated Roth account of the participant or to a Roth IRA owned by the participant. However, the rule will apply to subsequent distributions from the rolled over account or IRA within the 5-taxable year period.
Ordering rule for allocating taxable distributions. The IRS has prescribed ordering rules for purposes of allocating the taxable amount of a distribution from a Roth account to which a participant has made an in-plan rollover. Solely for purposes of the income acceleration rule and the 5-year recapture rule, a distribution from an in-plan Roth rollover account will be treated as attributable to an in-plan Roth rollover to the extent the distribution constitutes recovery of basis (determined under the rules of Code Sec. 72 and IRS Reg. §1.402A-1, Q-9).
Similarly, a distribution from a designated Roth account that, under the terms of the plan, is not paid from an in-plan Roth rollover account, will be treated as attributable to an in-plan Roth rollover to the extent the portion of the distribution that represents recovery of basis exceeds the basis in the designated Roth account other than the basis resulting from in-plan Roth rollovers.
Finally, the IRS explains, a distribution that is treated as attributable to an in-plan Roth rollover will be attributed to an in-plan Roth rollover on first-in-first-out basis. Under this rule, any amount attributed to the rollover will be allocated first to the taxable amount of the rollover.
CCH Note: The IRS had provided a detailed example illustrating the applicable rules.
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