Guidance Issued on In-Plan Roth Rollovers

From the IRS

The IRS has issued guidance on how plan participants can make rollovers from a 401(k) or 403(b) plan to a designated Roth account in the same plan (Notice 2010-84). Such in-plan Roth rollovers are now permitted under Sec. 402A(c)(4), as amended by the Small Business Jobs Act of 2010, P.L. 110-240, effective for distributions made after September 27, 2010.

New Sec. 402A(c)(4) allows Sec. 401(k) or Sec. 403(b) plans that include a qualified Roth contribution program to allow individual plan participants to roll over amounts in the plan to a designated Roth contribution account in the plan. For tax years beginning after 2010, this rollover treatment will also be available to Sec. 457(b) governmental plans. Participants must include the taxable amount of any rolled-over amount in gross income. The taxable amount is the amount that would have been included in the participant’s gross income if the rollover had been made to a Roth IRA.

The guidance in Notice 2010-84 consists of a series of 20 questions and answers. Among other things, the guidance clarifies that a rollover can be accomplished either as a direct rollover or by distributing the funds to the individual, who then must roll the funds over to his or her designated Roth account within 60 days.

The notice warns that participants who elect an in-plan Roth rollover cannot later unwind it (as can be done with Roth IRAs). The Sec. 408A(d)(6) recharacterization rule applies only to IRA contributions and not to in-plan rollovers.

The notice also states that direct in-plan rollovers will not be treated as a distribution in certain circumstances. For example, when a plan loan is rolled over, it will not be treated as a new loan. In addition, married participants are not required to obtain spousal consent for an election to make an in-plan direct rollover.

A plan must have a qualified Roth contribution plan in place at the time a rollover contribution to a designated Roth account is made. Plans will be allowed to add an in-plan Roth direct rollover option for amounts that would otherwise not be distributable under the terms of the plan (but are otherwise permitted under the Code). The IRS is extending the deadline for adopting plan amendments to provide for in-plan Roth rollovers. For Sec. 401(k) plans, the deadline for 2010 plan years is the later of the last day of the plan year for which the amendment is effective or December 31, 2011. For Sec. 403(b) plans, the deadline is the later of the end of the plan’s remedial amendment period under Announcement 2009-89 or the last day of the first plan year for which the amendment is effective.

Plans that offer in-plan Roth rollovers will be required to include a description of the feature in the written plan explanation they are required to provide under Sec. 402(f). The notice provides sample wording for this explanation.

In-plan direct rollover amounts are not subject to mandatory 20% withholding; however, the notice warns that participants who make an in-plan Roth rollover may need to increase their withholding or make estimated tax payments because the taxable amount of the rollover must be included in gross income. The taxable amount of the rollover is includible in the participant’s gross income in the year the distribution occurs. However, the IRS reminds taxpayers that for rollovers in 2010, the taxable amount is includible in gross income, half in 2011 and half in 2012, and the notice provides special income acceleration rules for distributions allocable to a 2010 in-plan Roth rollover.

The notice also provides special rules for applying the Sec. 72(t) 10% additional tax for distributions allocable to the taxable amount of an in-plan Roth rollover made within the preceding five years.