IRS releases rules for in-plan rollovers of Roth accounts

The IRS released rules in question and answer format for in-plan rollovers to designated Roth accounts in retirement plans (Notice 2013-74). The most significant part of the guidance concerns the mechanics of making an in-plan rollover of funds from Sec. 401(k), 403(b), or 457(b) governmental plans, which is now permitted for rollovers of “otherwise nondistributable amounts” (i.e., the plan participant has not reached age 59½ or left the company) made after Dec. 31, 2012.

These new rules for in-plan Roth rollovers under Sec. 402A(c)(4)(E) were added by Section 902 of the American Taxpayer Relief Act of 2012 (ATRA), P.L. 112-240, as a revenue raiser, because the rules permit rollovers of funds from the tax-deferred accounts noted above without being subject to the 10% penalty for early withdrawals in Sec. 72(t), but also result in the plan participants’ paying income tax on the amount of the rollover. Before the amendment, these rollovers could be made without the penalty only for “otherwise distributable amounts,” which meant the participant had to reach age 59½ or have a severance from employment.

The first question addressed is the effect of the new law on Notice 2010-84, which provided guidance on in-plan rollovers under pre-ATRA rules, including the provision permitting the inclusion of the amount taxable under the rollover over a two-year period in 2011 and 2012 (which is not available for the new rollovers). Notice 2013-74 explains that the rules under Notice 2010-84 (such as the vesting requirements) continue to apply to distributions of otherwise nondistributable amounts, but that the other rules do not, including the rule for a 60-day rollover and the rule under Sec. 402(f) requiring a written notice to recipients explaining the distributions eligible for rollover.

Any of the following amounts (including earnings on those amounts) in a Sec. 401(k), 403(b), or 457(b) governmental plan can be rolled over: Secs. 401(k) and 403(b) elective deferrals, matching contributions, and qualified nonelective contributions, and annual deferrals made to Sec. 457(b) governmental plans. Once these amounts are rolled over, they, and the amounts earned afterward, are subject to the rules restricting distributions before a participant reaches age 59½ or leaves employment at that company.

Because these rollovers are eligible rollovers under Sec. 3405(c)(1), no withholding can be made from these amounts to pay the taxes that will be due on the amounts rolled over. The notice advises employees making these rollovers to adjust their withholding or make estimated tax payments to avoid a penalty for underpayment of tax. 

Notice 2013-74 also contains the rules for making plan amendments to permit these types of rollovers. For Sec. 401(k) plans generally, these plan amendments usually must be made by the last day of the first plan year for which the amendment is to be effective. To give plan sponsors and plan participants more time (and probably also because this notice was released less than three weeks before the end of the year), the IRS is extending the deadline to the later of the last day of the plan year or Dec. 31, 2014, provided the amendment is effective as of the date the plan first operates in accordance with the amendment. For a calendar-year plan that wants to permit rollovers in 2013, the deadline is Dec. 31, 2014. The same deadlines apply to calendar-year Sec. 401(k) safe-harbor plans (those that use matching or qualified nonelective contributions to meet the nondiscrimination safe harbor) and to Sec. 457(b) governmental plans.

Sec. 403(b) plans, are permitted under the notice to make these amendments by the last day of the remedial amendment period that applies under Rev. Proc.  2013-22, or, if later, the last day of the first plan year in which the amendment is effective.  

The notice also contains a number of other questions and answers, including how a rollover will be treated for purposes of determining whether a plan is top-heavy under Sec. 416, and whether discontinuing in-plan Roth rollovers would violate the Sec. 411(d)(6) prohibition on decreasing accrued benefits.       

—Sally P. Schreiber (sschreiber@aicpa.org) is a JofA senior editor.