Proposed Roth 401(k) Regulations
Rev. 03/17/05, E-mail Alert 2005-5

On March 2, 2005, the IRS issued proposed regulations for Roth 401(k) plans.

The IRS issued proposed regulations for Roth 401(k) and 403(b) plans on March 2, 2005. The effective date for implementation is taxable years after December 31, 2005 and for plan years beginning on or after January 1, 2006. EGTRRA created Code Section 402A for the Roth 401(k) rules. Please note that the Roth type contribution is an optional plan design and is not required to be adopted by plan sponsors.

The proposed rules amend Treasury Regulation 1.401(k)-1(f) to add the rules for Roth contributions. Designated Roth contributions are defined as cash or deferred arrangement (CODA) elective contributions that are:

• Irrevocably designated as Roth contributions at the time of the deferral election;
  
• Treated by the employer as wages subject to the applicable withholding requirements at the time employee would have received the income.
  
• Maintained in a separate account within the plan.
  

With respect to the separate account requirement:

• Roth account (after-tax funds) must be kept in a separate account to ensure that the recordkeeping of on-going contributions and distributions reflects proper tax treatment under the Roth rules.
  
• Gains, losses and other credits or charges must be separately allocated on a reasonable and consistent basis to the designated Roth contribution account and other accounts under the plan.
  
• Forfeitures may not be allocated to the Roth contribution account.
  
• The separate treatment of Roth contributions must be maintained until the entire Roth account is completely distributed.
  

Roth Contribution Characteristics – once contributed to the plan, Roth contributions are treated much the same as other elective deferrals:

• They are nonforfeitable
  
• They are subject to the elective deferral withdrawal restrictions (age 59 ½ or hardship)
  
• They are subject to the ADP test, except for safe harbor 401(k) plans. Roth excess contributions are subject to the following tax treatment:
  
  • a. Roth excess contribution amounts that are distributed are not subject to income tax.
    
  • b. Any income allocable on an excess Roth contribution is distributed and is includible in gross income in the same manner as a distribution of a pre-tax excess contribution.
    
• Similar rules apply to ACP testing of a matching contributions made on Roth contributions.
  
• Unlike their Roth IRA “cousins”, Roth 401(k) contributions are subject to required minimum distribution rules of 401(a)(9)(A) and (B)
  

NOTE: Participants will have the right to designate some or all of their deferrals as Roth. If a participant has both types for a given plan year, they will have the option to designate which amounts are returned due to excess deferral or excess contributions refunded due to a failed ADP test.

The proposal would require specificity in certain plan terms governing Roth contributions. For example: the plan document must specify:

• the extent to which an employee may designate the distributions as coming from the Roth account,
  
• that Roth contributions may only be directly rolled to another Roth account or a Roth IRA.
  
• if a plan permits an HCE with both pre-tax elective contributions and Roth contributions to elect whether the excess contributions are to be attributed to the pre-tax elective contribution or the Roth contribution.
  

The IRS has requested comments on issues such as the taxability of early distributions of Roth contributions, presumably those that occur before age 59½ and prior to the end of the five-year waiting period. The IRS has also requested comments on any issues under Section 402A by May 31, 2005. The date of the public hearing will be announced in the Federal Register.