The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) included provisions that, beginning in 2006, would allow participants in a 401(k) plan to designate some or all of their elective contributions as after-tax Roth contributions. These Roth contributions would be similar to contributions to a Roth IRA assuming the plan follows all of the appropriate regulations.
How Does It Work?
Plan sponsors are not required to allow Roth contributions into their 401(k) plans. Should a plan sponsor wish to allow Roth contributions, their existing 401(k) plan will have to be amended. This amendment would not change the basic structure of the 401(k) plan but it would add the provisions necessary to allow Roth contributions. An employer establishing a new 401(k) plan on January 1, 2006, will be able to create the plan with the Roth provisions in place at inception.
Once the Roth 401(k) provisions are adopted, participants in the plan will have the ability to direct the plan sponsor to designate a portion or all of their elective contributions as Roth contributions. The Roth contributions must be treated as wages subject to the applicable withholding requirements. This differs from traditional 401(k) elective contributions which are before-tax contributions and not subject to federal income tax withholding. The Roth contributions must be deposited into a separate account from the traditional 401(k) elective contributions due to the differing taxation. Any gains in the Roth 401(k) account are tax-free if they are withdrawn with a qualified distribution.
How Much Can a Participant Contribute?
The Roth contributions are subject to the same contribution limits (Code Section 402(g)) as traditional 401(k) elective contributions. For 2006 the 402(g) limit is $15,000 ($20,000 if over age 50) – significantly higher than the Roth IRA contribution limit of $4,000 ($4,500 if over age 50). This limit is inclusive of a participant’s Roth contributions and traditional 401(k) salary deduction contributions. Roth contributions for Highly Compensated Employees (HCEs) are subject to the same discrimination testing as traditional 401(k) elective contributions.
When Can Distributions Of Roth 401(k) Contributions Begin?
Roth contributions are considered elective contributions and are therefore subject to the same withdrawal restrictions as traditional 401(k) elective contributions. The distributable events for elective contributions are termination of employment, death, disability, attainment of age 59½ or financial hardship (if provided under the plan), and plan termination. However, if Roth contributions are distributed prior to age 59½, death, or disability, they will not be considered a qualified distribution and will not be eligible for the tax-free status. Additionally, distribution of Roth contributions will not be eligible for the tax-free status if withdrawn within five years of the date the participant first made Roth contributions to the plan.
What Is The Future Of Roth 401(k)?
Rep. Benjamin Cardin (D-Md.) introduced the Pension Preservation and Savings Expansion Act of 2005 which includes language to repeal the Roth 401(k) provisions before they begin. If the Roth 401(k) provisions survive, there is currently an expiration date for EGTRRA of December 31, 2010. Therefore, if EGTRRA is not extended, the Roth 401(k) provisions would only be effective for the five-year-period of 2006 to 2010. The team of professionals at Uniglobal Pension Planning, Inc. will continue to monitor the status of the legislation and provide updates when necessary.
©2005 Uniglobal Pension Planning, Inc.