Guidance on In-plan Roth Conversions under the American Taxpayer Relief Act of 2012
Rev. 12/19/13, E-mail Alert 2013-22
The American Taxpayer Relief Act of 2012 (ATRA) signed into law on January 2, 2013 created the ability for a 401(k), 403(b) or governmental 457(b) plan which has a designated Roth provision for deferrals to add a provision to permit a participant to convert funds —for which the participant does not have a distributable event — to a designated Roth by an in-plan transfer. Section 902 of ATRA states:
“SEC. 902. AMOUNTS IN APPLICABLE RETIREMENT PLANS MAY BE TRANSFERRED TO DESIGNATED ROTH ACCOUNTS WITHOUT DISTRIBUTION.
(a) IN GENERAL. — Section 402A(c)(4) is amended by adding at the end the following:
(E) SPECIAL RULE FOR CERTAIN TRANSFERS.—In the case of an applicable retirement plan which includes a qualified Roth contribution program—
(i) the plan may allow an individual to elect to have the plan transfer any amount not otherwise distributable under the plan to a designated Roth account maintained for the benefit of the individual,
(ii) such transfer shall be treated as a distribution to which this paragraph applies which was contributed in a qualified rollover contribution (within the meaning of section 408A(e)) to such account, and
‘‘(iii) the plan shall not be treated as violating the provisions of section 401(k)(2)(B)(i), 403(b)(7)(A)(i), 403(b)(11), or 457(d)(1)(A), or of section 8433 of title 5, United States Code, solely by reason of such transfer.
(b) EFFECTIVE DATE.—The amendment made by this section shall apply to transfers after December 31, 2012,in taxable years ending after such date.”
IRS Guidance Issued as Notice 2013-74
The IRS guidance necessary to administer this new law was issued as Notice 2013-74 on December 11, 2013 and is entitled: In-plan Roth Rollover Rules for the Small Business Jobs Act of 2010 and for the American Taxpayer Relief Act of 2012.
Although we expected the IRS to issue guidance on in-plan Roth transfer, the guidance treats SBJA and ATRA in-plan Roth conversion transactions as in-plan Roth rollovers. From a tax reporting point of view, this makes sense as the term rollover typically reflects a reportable event which must be reported on a Form 1099-R. A transfer, like a transfer of trusteeship between two IRAs or a transfer of assets when two qualified plans merge is not a reportable event; and thus, a transfer is not reported on a Form 1099-R.
Amendment Timing; Provided by Plan Type
For 401(k), Safe Harbor 401(k) & Gov’t. 457(b) plans, the amendment must be adopted by the later of last day of first plan year that the IRR amendment is effective or December 31, 2014.
Thus, for a calendar year plan starting IRRs in 2013 or 2014; the plan amendment, adding the in-plan Roth Rollover (IRR), must be adopted by December 31, 2014.
In addition, a safe harbor 401(k) may adopt the IRR amendment mid-year without violating the safe harbor notice rules. Although the safe harbor 401(k) plan usually may not be amended mid-year, the IRS has consistently in Announcement 2007-59 and Notice 2010-84 and now in Notice 2013-74 permitted Roth provisions to be added and IRRs to be added mid-year to a safe harbor 401(k) plan without violating the safe harbor rules.
For 403(b) plans that timely adopted a written plan (or who filed under EPCRS as a non-amender and received a letter of compliance), has until the last day of the 403(b) Remedial Amendment Period (RAP) to adopt the IRR amendment. This date is to be announced when the preapproved plans are approved by the IRS. If a new 403(b) plan is opened after the end of the RAP, the last day of the plan year in which the IRR was first effective.
Notice 2010-84 to Apply to Both SBJA and ATRA IRRs
IRS guidance in Notice 2010-84 for IRR under SBJA is cited as applicable to all in-plan rollovers under SBJA and ATRA with the exceptions and changes noted in the Notice 2013-74. An IRR under ATRA amounts need not have a distributable event. Under Notice 2010-84, to be eligible for an IRR, the amounts must be vested. Notice 2013-74 states that the same vesting rules apply to an IRR under ATRA.
The guidance introduces new terminology. Specifically, the “Otherwise Nondistributable Amounts” (ONA) which is used for amounts not eligible to be distributed but that may be converted by an in-plan Roth rollover. ATRA Section 902 used this term. In addition, the guidance introduces the term “Otherwise Distributable Amounts” (ODA) representing amounts eligible for distribution that could be converted under in-plan Roth Rollover guidance from SBJA, i.e. Notice 2010-84.
Sources Available for IRR of an Otherwise Nondistributable Amount Include:
- Elective deferrals plus earnings
- Matching Contributions
- Nonelective Contributions
- QNECs and QMACs
- Annual deferrals in Governmental 457(b), including the federal government’s Thrift Savings Plan
IRR Rules for Otherwise Nondistributable Amounts (ONAs): Withdrawal Restrictions
The distribution restrictions on the original source must remain on the ONA source after the IRR conversion.
The Revenue Ruling 2004-12 portability rules — permitting amounts rolled into the plan to be rolled out at the participant's request — do not apply to the IRR of an ONA. For example, a 401(k) participant who makes an IRR of an ONA withdrawal restricted source and who has not severed employment and is under age 59½, may not take a distribution of that amount until age 59½, severance or another distributable event.
Rules That Apply Only to SBJA IRRs Under Notice 2010-84 and Not to ATRA IRRs
Two rules apply only to SBJA IRR amounts, i.e. Otherwise Distributable Amounts (ODAs). One, an IRR may be done by an in-plan 60-day rollover; and two, a revised 402(f) notice must be provided. Thus, a revised 402(f) Notice is not required for only an ATRA IRR for an Otherwise Nondistributable Amount (ONA).
Withholding Rules for Otherwise Nondistributable Amounts (ONAs)
There is no mandatory 20% withholding on the IRR of an ONA amount. Even though this is reported as a direct rollover, i.e. Code “G” in Box 7 of the Form 1099-R, there is no actual distribution from the plan, and thus no mandatory withholding. Likewise, there is no voluntary withholding. Since otherwise Nondistributable Amounts are not eligible for distribution, voluntary withholding cannot be requested on such amounts.
As taxes are due on IRRs, the IRS guidance reminds us to inform the employee that he or she may need to file estimated tax withholding payments or increase withholding on wages to pay for the conversion.
IRR Rules for ONAs: Plan Options
Notice 2013-74 states that a plan may restrict the type of contributions eligible for IRR and the frequency of IRRs; subject to section 401(a)(4) benefits, rights and features testing. For example, a plan could provide that ONLY Otherwise Distributable Amounts are eligible for IRR (i.e. use only the SBJA IRR rules under Notice 2010-84). As such, the plan would not have to separately account for withdrawal restricted IRR amounts.
The ability of a plan to restrict the sources available for IRRs may also be useful for 401(k) plans containing assets merged from a former money purchase plan that have been kept separately sourced as money purchase assets. A plan sponsor may amend the plan to add ATRA in-plan Roth rollovers, but exclude “money purchase plan assets” in order to avoid separate accounting of those as in-plan Roth rollovers subject to the QJSA rules.
The plan’s ability to restrict the frequency of in-plan Roth rollovers may help avoid administrative burdens and the possibility of additional recordkeeping fees.
ADDITIONAL IRR RULES IN NOTICE 2013-74
IRR Provision is Not a Protected Benefit
IRR provisions are not protected benefits and may be removed from the plan prospectively. Notice 2013-74 states that amending out the IRR provision is subject to the anti-abuse provision of 1.401(a)(4)-5 and should not have the effect of discriminating significantly in favor of the HCEs or former HCEs.
Net Unrealized Appreciation
An IRR is a taxable distribution triggering the net unrealized appreciation rules if employer securities are part of all IRRs.
“Related Rollover” for Top Heavy Purposes
An IRR is a “related rollover” for top heavy purposes and must be counted in the determination date balances as a related rollover.
If an Employee rolls all of his or her funds via an IRR, and then it is later determined that all or a portion of the IRR is an excess deferral, excess contribution or excess aggregate contribution that must be distributed from the plan, the excess plus applicable earnings is to be distributed from the designated Roth account regardless of whether it is an ONA or an ODA.
Attached are slides created and taught during our designated Roth class on Dec. 12, 2013.
Bill Grossman, ERPA, GFS, QPA, APA
For more information click here for details on our Designated Roth Account and
Roth Conversions eSeminar
on January 22, 2014.
This eSeminar was taught on December 12, 2013 with the ATRA material included and is available as a recording now. To register for the recorded version, contact us at 973-492-1880.
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