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Roth Conversions for 2010 Require Immediate Action by Plan Sponsors of Defined Contribution Plans
October 8, 2010
On September 27, 2010, President Obama signed into law The Small Business Jobs Act of 2010 (the “Jobs Act”). The Jobs Act now permits 401(k) and 403(b) plans to provide participants the option of transferring money within the plan from a pre-tax account to a Roth account maintained by the same plan so long as the amount to be transferred is otherwise eligible for distribution under the plan. Prior to the Jobs Act, a participant could only convert a pre-tax account to a Roth account by distributing the money out of the plan. This provision is effective immediately for 2010.
Beginning in 2011, governmental 457(b) plans also will be permitted to offer Roth accounts and provide for Roth conversions within the plan.
Participants Can Transfer Amounts into a Roth Account Maintained By the Same Plan
Participants in 401(k) and 403(b) plans are permitted to elect a rollover of pre-tax amounts from the plan to a Roth IRA, regardless of the participant’s modified adjusted gross income so long as the amounts were otherwise available for distribution from the plan. Generally, the participant should include the amount of the rollover in gross income at the time of the transfer (although the 10 percent early distribution penalty would not apply). However, if the rollover is in 2010, the participant would include half of the taxable amount of the rollover in the participant’s 2011 gross income and half in the participant’s 2012 gross income, unless the participant elected to include the entire rollover in the participant’s 2010 gross income.
Under the Jobs Act, a participant who is otherwise eligible for a distribution can now transfer pre-tax amounts in the plan that qualify as an eligible rollover distribution into a Roth account maintained by the same plan. This permits participants to leave their money in the plan while still taking advantage of the Roth rollover rules. In order for a participant to take advantage of the new rules, the relevant plan must permit Roth contributions, the amounts being rolled over must qualify as an eligible rollover distribution and the participant must be eligible for a distribution under the plan. Plan sponsors will need to amend their plans to permit Roth accounts and/or taxable transfers of pre-tax amounts into the plan’s Roth account. The IRS may provide employers a remedial amendment period to amend the plan for 2010 transfers to Roth accounts; however, plan sponsors will need to be ready to make the amendments prior to the end of the year for 2010 transfers if the IRS does not extend the amendment period. Given rollovers and transfers of pre-tax amounts to Roth IRAs and Roth accounts, respectively, are only available for amounts otherwise eligible for distribution, plan sponsors may want to consider amending their plans to expand when participants are eligible to receive their accounts. For example, the plans may be amended to permit distributions of elective deferrals at age 59½ or profit sharing dollars after five years of participation.
These new rules are effective immediately, and if the plan is amended now to permit in-plan rollovers, participants can take advantage of the special tax rules which allow tax due on 2010 rollovers to be deferred into 2011 and 2012.
Roth Contributions Are Now Permitted Under Governmental 457(b) Plans
Prior to the Jobs Act, governmental 457(b) plans were not permitted to have a Roth account. The Jobs Act now permits governmental 457(b) plans to include a Roth feature and thus eliminates one of the distinctions between governmental 457(b) and 401(k) or 403(b) plans. This provision under the Jobs Act becomes effective January 1, 2011. A governmental 457(b) plan that is amended to include a Roth feature can also take advantage of the in-plan Roth conversion provisions of the Jobs Act effective January 1, 2011.
If you have any questions about the new guidance, please contact any member of the Troutman Sanders’ Employee Benefits & Executive Compensation Practice Group.