7.20 Designated Roth Contributions to 401(k) Plans

Employers with 401(k) plans may allow employees to irrevocably designate all or part of their pre-tax elective salary deferrals (and catch-up contributions if age 50 or older) as after-tax Roth contributions. The plan must be amended to allow Roth contributions. The Roth contributions, being after-tax, are treated as taxable wages subject to withholding.

The major incentive for employees to designate 401(k) plan contributions as Roth contributions is to obtain tax-free treatment for distributions under the qualified distribution rules applicable to Roth IRAs. That is, distributions of designated Roth contributions plus accrued earnings would be totally tax free if received after age 59½ and a five-year holding period (8.23).

Roth 401(k) contributions are available to individuals who might otherwise be unable to make annual contributions to a Roth IRA. Subject to 401(k) nondiscrimination tests, there are no income limitations on the right to make Roth 401(k) contributions, whereas contributions to a Roth IRA are barred if adjusted gross income exceeds an annual threshold (8.20).

Law Alert

In-Plan Conversion From 401(k) to Roth 401(k)

Employers with 401(k), 403(b), or governmental 457 plans may permit employees to roll over distributions (otherwise eligible for rollover) of vested amounts to a designated Roth account within the same plan. An in-plan Roth rollover is taxable unless attributable to after-tax contributions.

- - - - - - - - - -

Plans must segregate designated Roth contributions from regular 401(k) elective deferrals and maintain separate accounts for employees with both types of contributions. Gains, losses, and other credits or charges, as well as contribution and withdrawals, must be allocated between the accounts on a reasonable and consistent basis. Designated Roth contributions are subject to the 401(k) nonforfeitability and distribution restrictions and also to the nondiscrimination tests for pre-tax elective contributions.

403(b) plans.

Under similar rules, designated Roth contributions may be made available under 403(b) plans (7.21) sponsored by public schools and tax-exempt organizations.

In-plan Roth rollovers.

Employers may (but do not have to) allow employees to roll over amounts(if eligible for rollover (7.7)) from their 401(k), 403(b), or governmental 457(b) plan to a designated Roth account within the same plan. An in-plan Roth rollover is taxable except to the extent attributable to after-tax contributions; this is the same rule as for a conversion of a traditional IRA to a Roth IRA. The taxable amount will be reported on Form 1099-R; Code G will be entered in Box 7. Unlike a conversion to a Roth IRA, which may be recharacterized (8.22), an in-plan rollover to a designated Roth account may not be recharacterized.