IRS guidance on in-plan Roth conversions

Milliman issued a benefit alert today:

The IRS recently issued guidance on the in-plan Roth transfer option permitted by the Small Business Jobs Act of 2010. This option permits plans to be amended to allow participants to transfer eligible pretax 401(k) or 403(b) contributions and vested employer contributions into a designated Roth account within the same plan. If you choose to add this feature in 2010, plan participants may take advantage of special tax treatment available for conversions made in 2010 only.

Required Modifications to the Plan

Under IRS Notice 2010-84, you need not amend the plan to adopt in-plan transfers to designated Roth accounts until Dec. 31, 2011, even if you offer the transfers in 2010. (Different deadlines may apply to 401(k) safe harbor plans or 403(b) plans.) To offer the Roth transfers, the following steps generally apply:

1.   A board resolution should be signed, indicating the intent to adopt an in-plan Roth transfer provision and the date of the provision.

2.   If your plan does not currently allow contributions to a designated Roth account, it must be amended by the deadline, and the Roth account must be in place and participants must have an opportunity to make Roth contributions prior to the date of the first in-plan Roth transfer.

3.   Any amounts that could be distributed and rolled over to an IRA or a qualified plan can be made available for in-plan Roth transfers. The plan may be amended to add in-service withdrawal options. For example, if the plan does not currently allow age 59-1/2 withdrawals, you may add them now to allow in-plan Roth transfers for participants who have reached age 59-1/2. (If you add any in-service options to the plan, you may limit them to participants electing a Roth transfer.)

Other Considerations

If you proceed with the new option, you may wish to consider:

  • Developing a communication strategy to inform participants about the addition of the new in plan transfer option, as well as any additional withdrawal options or the implementation of a Roth feature if your plan does not currently have one.
  • Revising in-service withdrawal election forms to allow participants to elect an in-plan Roth transfer. Additional language will also need to be added to the “Special Tax Notice” that is provided to participants when they receive a rollover eligible distribution from the plan.
  • Treating as taxable income any funds transferred from pretax accounts to designated Roth accounts, including reporting of such amounts on IRS Form 1099-R, even though no actual distribution from the plan has been made. However, such transfers are not subject to the 10% early withdrawal penalty and the mandatory 20% withholding that applies to other rollover eligible distributions does not apply.
  • A special rule applicable only for 2010 allows participants to defer taxes on amounts converted by Dec. 31, 2010, to 2011 and 2012, with taxes to be paid equally when they file their federal income tax returns for those two years. Participants electing a Roth transfer option in 2010 will need to file IRS Form 8606, Nondeductible IRAs, with their 2010 federal tax return, even if they elect to defer paying the federal income tax due on the converted amounts to the 2011 and 2012 tax filing dates. As the plan administrator, you do not need to track the participants’ election.

The IRS’s “Employee Plans News” newsletter contains information that may be helpful in your decision to proceed. It is available here.  

For additional information about the IRS’s guidance or for assistance with drafting board resolutions and plan amendments, revising summary plan descriptions, and preparing communications materials, please contact your Milliman consultant.