Roth 401(k) Revisited

by Larry Shippee 

Since Roth 401(k) contributions were introduced this year, they have been described by some as the most important new benefits since 401(k) itself.  Others have dismissed the Roth as confusing and unnecessary.  One thing is for certain, there are still many unanswered questions about how these plans are to be operated.

Roth type contributions to a 401(k) plan first became available in 2006.  See "Get Ready for the Roth 401(k)" at http://www.benefitsconsulting.net/ for an overview.  Final regulations were issued December 30, 2005 answering some of the questions.  On January 26, 2006 the IRS released proposed regulations that provided further guidance.

Here's where we are now on some of the relevant issues.

A plan must offer normal 401(k) contributions before it can add a Roth option.  Thus, you can't have a Roth only 401(k) plan.

The final regs clarify that catch up contributions can be designated as Roth contributions.

Roth contributions in a 401(k) plan are subject to the minimum distribution rules (starting at age 70 ½).  Roth IRA's are not.

Roth 401(k) accounts can be rolled over to another 401(k) plan that allows Roth contributions or to a Roth IRA.  Roth IRA cannot, however, be rolled to a Roth 401(k).

 

Roth 401(k) accounts become "qualified" and therefore can be distributed tax-free if the account is 5 years old and the participant is at least age 59 ½.  The 5-year clock starts at the beginning of the first taxable year a Roth 401(k) contribution is made.

Here are some of the problems with Roth accounts.

If the funds are distributed prior to the time the account meets the "qualification" requirement (5 years and 59 ½), the earnings are taxable.  The contributions are not taxable.  This means a basis must be maintained.  As accounts transfer from plan to plan or from plan to IRA, maintaining this information may be difficult.  The regulations indicate who is responsible for maintaining the information in these circumstances.

If a distribution includes both taxable and nontaxable amounts, the situation can get complicated.  This is especially true if there is a partial distribution.  How much is taxable and how much isn't.  This is one area where more guidance from the IRS is needed.

RECOMMENDATION

While Roth accounts can be added now, it may be advisable to wait until some of the answers are clear and better recordkeeping capabilities exist.