he Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) (section 617) added a provision allowing IRC section 401(k) plan participants to designate part or all of their plan contributions as Roth 401(k) contributions. IRC section 402A—the new EGTRRA provision —is scheduled to become effective on January 1, 2006, for 401(k) plans that have been amended to allow such contributions.
Although contributions are not excluded from income, distributions will not be taxed, provided certain criteria are met. CPAs should become familiar with the law and with the proposed regulations, issued in March 2005, to advise employer or worker clients.
A designated Roth 401(k) contribution must meet three requirements to qualify as such. First, the employee must irrevocably designate amounts as Roth 401(k) contributions when electing to defer compensation. The taxpayer cannot decide later that tax savings are needed for the current year and redesignate the contribution as having been made to a regular IRC section 401(k) plan. Employees can change or revoke the designation only for future deferrals.
Second, contributions must be included in income at the time the employee would have received the funds had he or she not elected to contribute to the qualified Roth contribution program. Finally, deferred amounts must be maintained by the plan in a separate, designated Roth account.
For distributions from a Roth 401(k) to be nontaxable, they must occur after the five-year period beginning with the tax year of the employees first contribution. Distributions must be made (1) on or after the taxpayer attains age 59 , (2) after the taxpayer’s death or (3) on account of the taxpayer’s disability.
The designated Roth 401(k) provides an attractive new retirement savings opportunity for taxpayers. They now may invest larger amounts in a wide variety of accounts, including mutual funds, bonds, publicly traded stock and employer stock. The contributions are subject to the IRC section 402(g) limit on elective deferrals ($15,000 in 2006, with a $5,000 catch-up for those age 50 and over). Also, all participants, regardless of income, will be eligible to make designated Roth contributions.
Distributions are required once an employee reaches 70 . However, Roth 401(k) plan assets can be rolled over into a Roth IRA, for which distributions are not mandatory, and the taxpayer still can make Roth IRA contributions.
The Roth 401(k) provisions will allow a traditional 401(k) plan to function much like a Roth IRA. Unfortunately, there currently is no way to transfer funds from the traditional 401(k) plan to a Roth 401(k); this problem most likely will be addressed in future guidance.
For more information, see the Tax Clinic, edited by Mike Koppel, and “Employee Benefits & Pensions: Current Developments (Part II)” by Deborah Walker and Michael Haberman, both in the December 2005 issue of The Tax Adviser.
—Lesli S. Laffie, editor
The Tax Adviser
|Notice to readers: Members of the AICPA tax section may subscribe to The Tax Adviser at a reduced price. Contact Judy Smith at 202-434-9270 for a subscription to the magazine or to become a member of the tax section. |