The Ins and Outs of In-Plan Roth Rollovers
By Catherine Corrado
What is an In-Plan Roth Rollover (IRR)?
An IRR allows a plan participant, spouse beneficiary, or a QDRO recipient who is a spouse or a former spouse in a 401(k) plan, 403(b) plan, or governmental 457(b) plan to roll over non-Roth assets to a designated Roth account under the plan.
What are the plan requirements to offer an IRR?
Before an employer allows IRRs, it must allow participants to make Roth elective deferrals. If an employer does not already offer a designated Roth contribution program, it generally must amend the plan document to add this provision before it can allow for IRRs. And although IRS guidance does not specifically state this, as a practical matter, an employer should accept (or amend the plan to accept) designated Roth rollover contributions from other plans before it allows IRRs.
How are IRRs processed?
IRRs can be processed either as a direct rollover or as an indirect rollover. In a direct rollover, the assets that are eligible for rollover are moved directly from a non-Roth account to the designated Roth account under the same plan. In an indirect IRR, the eligible rollover assets are distributed to the individual. The individual then has 60 days to roll back the assets into the same plan from which they were distributed.
In both situations, the assets must be rolled into a designated Roth account within the same retirement plan. An individual cannot roll over non-Roth assets into a designated Roth account from another employer’s retirement plan.
What are the notification requirements?
When an employer decides to offer the IRR feature, it must also notify participants that this feature is available. This notice can be provided to participants through the summary of material modifications (SMM) or the summary plan description (SPD). IRS Notice 2013-74 states that the 402(f) notice requirements do not apply to direct IRRs unless the individual is eligible to receive a distribution under the plan. All indirect IRRs follow the normal distribution notice requirements, including spousal consent, if applicable.
Are there any contribution restrictions when requesting an IRR?
The plan document will specify the contribution sources and vesting rules available for an IRR. The assets must also meet the definition of an eligible rollover distribution. Required minimum distributions, hardship distributions, and permissive withdrawals under an automatic enrollment arrangement are a few examples of distributions that aren’t eligible for rollover. The employer can also include an outstanding loan balance as part of a direct IRR.
What are the tax implications?
The taxable portion of the IRR will be included in the individual’s gross income for the year of the rollover. The taxable amount is the value of the distribution reduced by the individual’s basis (e.g.,
after-tax or nondeductible employee contributions), if any. The employer must report the taxable and nontaxable amount of the IRR on IRS Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
Are IRRs subject to the 10 percent early distribution penalty tax or the mandatory 20 percent federal withholding rule?
The 10 percent early distribution penalty tax does not apply unless a distribution is taken within five years of the IRR (known as the five-year recapture rule). This rule is in place to discourage individuals from processing an IRR and then immediately taking a tax-and penalty-free distribution from their account.
The mandatory 20 percent federal income tax withholding rate applies only to indirect IRRs. If an individual requests an indirect IRR, she can choose to make up the 20 percent withholding amount out-of-pocket and roll over the entire distribution amount.
Employers must track the distribution order of IRR assets and report the distribution amount that is allocated to an IRR within its applicable five-year recapture period, which can be complicated. IRS Notice 2010-84 provides additional guidance.
Employers should consult with a competent tax or financial advisor to determine if this strategy is appropriate for their plan. More information on IRRs can be found at the IRS’s website.
