CUNA Regulatory Comment Call
Designated Roth Contributions to 401(k) Plans
May 2, 2005
- Under proposed Internal Revenue Service (IRS) regulations, employees could elect to defer after-tax contributions to Roth Section 401(k) plans beginning in 2006. The proposed rules also provide guidance on matching designated Roth contributions under Section 401(m). These proposed regulations implement Section 402A of the Internal Revenue Code, which was added by the Economic Growth and Tax Relief Reconciliation Act of 2001.
- Although the Roth contributions could be included in employees' gross incomes, the plans' distributions would be tax-free, according to the proposal.
- The guidance in the proposal would be used to ensure that affected Section 401(k) plans comply with separate accounting and recordkeeping requirements under Section 402A of the Internal Revenue Code (Code). Section 402A is effective for taxable years beginning after Dec. 31, 2005, and apply to plan years beginning on or after Jan. 1, 2006.
- Comments are due to the IRS by May 31, 2005. Please send your comments to CUNA by May 20, 2005. Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Associate General Counsel Mary Dunn at firstname.lastname@example.org or to Senior Regulatory Counsel Catherine Orr at email@example.com; or mail them to Mary or Catherine in c/o CUNA's Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, 6th Floor - South Building, Washington, DC 20004. You may also contact us at 800-356-9655, ext. 6743, if you would like a copy of the proposed rule, or you may access it here.
DESCRIPTION OF THE PROPOSAL
- Under Code Section 402A, beginning in 2006 a 401(k) plan may permit an employee who makes elective contributions under a qualified cash or deferred arrangement to designate some or all of those contributions as Roth contributions.
- The proposed rules clarify that although designated Roth contributions are elective under a qualified cash or deferred arrangement, they currently can be included in gross income. However, qualified distributions are excludable from gross income.
- The proposal defines designated Roth contributions as elective contributions under
qualified cash or deferred arrangements that, to the extent permitted by the plan, are:
- Designated irrevocably by the employee at the time of the cash or deferred election as designated Roth contributions (the Roth election has to be designated irrevocably at the same time as the elective deferrals under a regular 401(k) plan and cannot be recharacterized later);
- Treated by the employer as includible in the employee's income at the time the employee would have received the contribution amounts in cash if the employee had not made the cash or deferred election; and
- Maintained by the plan in a separate account. This is because the taxation of the distributions differs from a regular 401(k) plan; a Roth distribution is not taxable, while distributions from a regular 401(k) plan are taxed.
- The contributions and withdrawals of designated Roth contributions must be credited and debited to separate accounts maintained for employees who make the designations. Plan sponsors must also maintain records of the employee's investment contract for their Roth contribution accounts.
- Moreover, gains, losses, and other credits or charges are to be allocated separately "on a reasonable and consistent basis to the designated Roth contribution account and other accounts under the plan," but forfeitures may not be allocated to the accounts.
- The separate accounting requirement applies at the time the contribution is made and must continue to apply until the Roth contribution account is completely distributed.
- Contributions are subject to the nonforfeitability and distribution restrictions
applicable to elective contributions and are taken into account under the actual deferral
percentage (ADP) test of Section 401(k) in the same manner as pretax elective contributions.
(See 26 C.F.R. §1.401(k)-2.)
- All 401(k) plans are prohibited from discriminating in favor of highly compensated employees. They must comply with the usual battery of nondiscrimination tests. This means that the plan must pass minimum coverage and general nondiscrimination tests. If the plan accepts employee after-tax contributions or if the plan provides for employer matching contributions, the Section 401(m) Matching Test must be performed as well. This annual test is also known as the Average Contribution Percentage test, or ACP.
- Section 401(k) plans are also subject to a special nondiscrimination test limiting
elective deferrals for highly compensated employees. This special test, or ADP test,
must generally be performed annually. Elective deferrals consist of employee before-tax
contributions made on a voluntary basis. To perform the ADP test, eligible employees
those eligible to participate in the plan, whether or not they actually participate are
divided into two groups: highly compensated employees (HCEs) and nonhighly compensated
employees (NHCEs). Within each group, the amount of each employees elective deferral,
as a percentage of compensation, is determined. The percentages for each employee are
totaled and averaged to get the average deferral percentage for each group. Next, the
ADP for the HCE group is compared with the ADP of the NHCE group to determine if the plan
passes the test according to these formulas:
- If the ADP for the NHCE group is 2 percent or less, the plan passes if the ADP for the HCE group is not more than twice the ADP for the NHCE group.
- If the ADP for the NHCE group is more than 2 percent but not greater than 8 percent, the plan passes if the ADP for the HCE group is not more than 2 percent greater than the ADP for the NHCE group.
- If the ADP for the NHCE group is more than 8 percent, the plan passes if the ADP for the HCE group is not more than 125 percent of the ADP for the NHCE group.
- Contributions are subject to the minimum required distribution rules of Section 401(a) (9)(A) and (B) in the same manner as pretax elective contributions. (See 26 U.S.C. §401(a) (9)(A) and related regulations). Contributions are subject to lifetime minimum distribution requirements as long as they are in the 401(k) plan. After the individual leaves employment and the funds roll into an individual retirement account (IRA), then the funds are going to be subject to Roth IRA rules. Under the Roth IRA rules, the funds are not subject to lifetime minimum distribution.
- Correction methods in the final regulations under Section 401(k) for plans that fail the ADP for a year would be amended to permit highly compensated employees with elective contributions for a year that includes both pretax elective contributions and designated Roth contributions to elect whether excess contributions are to be attributed to pretax elective contributions or designated Roth contributions.
- A distribution of excess contributions is not includible in income to the extent that it represents a distribution of designated Roth contributions. However, the proposed rules note that the income allocable to a corrective distribution of excess contributions that are designated Roth contributions is includible in gross income in the same manner as income allocable to a corrective distribution of excess contributions that are pretax elective contributions.
QUESTIONS REGARDING THE PROPOSAL
- The proposed regulations do not provide guidance regarding the taxation of the distribution of designated Roth
contributions. For example, the proposed regulations do not provide guidance regarding the recovery of an employees
investment in the contract associated with his/her designated Roth contributions. The IRS requests comments on the
issues on which guidance is needed with respect to the taxation of such distributions.
- It is noted that information collection proposed in the guidance would be used to ensure that affected Section
401(k) plans comply with separate accounting and recordkeeping requirements. Do you agree with those accounting and
Yes _____ No _____
Why or why not?
- Other comments?
Eric Richard General Counsel (202) 508-6742 firstname.lastname@example.org |
Mary Mitchell Dunn SVP & Associate General Counsel (202) 508-6736 email@example.com
Jeffrey Bloch Assistant General Counsel (202) 508-6732 firstname.lastname@example.org
Lilly Thomas Assistant General Counsel (202) 508-6733 email@example.com
Catherine Orr Senior Regulatory Counsel (202) 508-6743 firstname.lastname@example.org