Roth 401(k) Overview:
On January 1, 2006, employees can choose to make their 401(k) contributions before-tax or after-tax, or a combination of both. The contribution limits that apply to these 401(k) contributions made in 2006 (either before or after taxes or both) are:
1. $15,000 below the basic limit, plus,
2. Additional $5,000 for employees age 50 and older.
oThe employer remains responsible for withholding federal income tax (and state and local income tax, where applicable) and any applicable payroll taxes on the after-tax portion of each employee’s 401(k) contribution .
*While no federal (or state or local, as applicable) income tax is withheld from pre-tax contributions, payroll taxes will apply to amounts withheld as pre-tax contributions.
oIn the absence of additional IRS guidance, pre- and post-tax contributions will be reported on each employee’s W-2 as they are now. We expect the IRS (prior to the issuance of Form W-2 for tax year 2006) to provide a new code to use on Form W-2 for the after-tax portion of contributions.
oA separate recordkeeping account must be established for each participant who wishes to make Roth 401(k) contributions.
Roth 401(k) Rules
To help you with your decision, it’s important to understand the Roth 401(k) rules:
o Roth 401(k) accounts must be separate accounts: after-tax contributions cannot be combined with pre-tax contributions.
o Distributions from the Roth 401(k) will be tax-free for federal income tax purposes, provided both a 5-year holding period and a qualifying event requirement are met:
a) The 5-year holding period begins with the first contribution to any Roth 401(k) account in the employer plan.
b) Qualifying events are strictly limited to entertainment of 59 1/2 years of age, death or disability.
Transfers to a Roth 401(k) can be made from other employer-sponsored Roth accounts. If you transfer to a Roth 401(k), the 5-year holding period begins on the date the transferred account is established or the date the receiving Roth account is established, whichever comes first.
Our reservations
The following is a summary of our reservations. Please contact our office for more information in greater detail.
A. The IRS is required to issue guidance clarifying that the determination of the five-year taxable holding period is based on a calendar year rather than the plan year.
B. Requiring the receiving plan administrator to be responsible for tracking eligible rollovers of Roth contributions in a 401(k) plan and the time a Roth contribution was first made would be an impediment to accepting rollovers of Roth contributions and would effectively restrict the transfer of these amounts. Participants should be responsible for keeping track of both the basis in the rollover account and when a Roth contribution was first made.
C. Sponsors of plans that allow Roth contributions must also have the ability to include plan provisions that establish rules regarding the order of account sources for all types of plan distributions.
D. The IRS must issue sample or good faith amendments that plan sponsors can use without affecting reliance on predetermination letters, notification letters, or opinion letters as to the qualification of the terms of their plans.
E. Sponsors of 401(k) plans that allow Roth(k) contributions and who wish to implement an automatic enrollment feature must be able to choose whether pre-tax elective or Roth(k) contributions will be the default election for participants.
F. Sponsors of 401(k) plans that allow Roth(k) contribution programs must be able to place limitations on the ability and frequency of plan participants to choose between Roth(k) and elective pre-tax contributions in a year certain calendar. without violating IRS rules.
G. A new form Notice of Distribution will be required to account for pre-tax and designated Roth elective contribution distributions. The current model already has 6 pages.
H. A plan sponsor must be able to maintain a plan that allows only Roth contributions and no pre-tax salary deferrals.
Final note
Again, we recommend that Employers and Sponsors of 401(k) Plans considering adopting the Roth provisions give serious consideration to the above reservations. Perhaps it is better to let others run ahead and see how they fare.