FAQ: Roth 403(b)¹
Multnomah Group, Inc.
What is a Roth 403(b)?
Organizations sponsoring 403(b) plans may allow participants to make Roth 403(b) contributions on an after-tax basis. When a plan sponsor elects to add a Roth 403(b) feature, Roth 403(b) contributions are recordkept separately from other contributions to the plan so that the special rules applicable to Roth 403(b) contributions may be followed. In this way, the Roth 403(b) is not a separate retirement plan, but rather it is a unique feature of the 403(b) plan sponsored by the organization. Participants simply direct desired contributions in their chosen proportions (up to the stated legal maximums) to the pre-tax 403(b) deferral source and/or the after-tax Roth 403(b) source using the administrative processes supported by the plan sponsor and the recordkeeping vendor. The participant’s decision to designate certain contributions as Roth contributions is irrevocable.
What are the potential benefits of adding a Roth 403(b) feature to the 403(b)plan?
Adopting a Roth 403(b) feature allows participants to contribute after-tax dollars to their retirement plan account. Earnings, if any, on the Roth 403(b) contributions grow on a tax-free basis, meaning that participants will not pay income tax on distributions from the Roth 403(b) contribution source. In addition to the avoidance of tax on Roth earnings, highly compensated participants who are not able to make Roth IRA contributions because their adjusted gross income is higher than the established maximum are not subject to similar income restrictions when deciding whether to make Roth 403(b) contributions. Unlike Roth IRAs, there are no maximum income limits for Roth 403(b) contributions.
What types of employees are more likely to benefit from the Roth 403(b) feature?
The following types of employees are more likely to benefit from the addition of a Roth 403(b) feature:
- Participants who have a longer period of time until retirement, giving them a longer period of time to accumulate tax-free earnings.
- Participants who expect to be in a higher tax bracket later when they take distributions from the Roth 403(b) contribution source.
- Highly compensated employees who are not eligible for a Roth IRA due to adjusted gross income thresholds.
- Participants who want to ensure that their beneficiaries receive tax-free dollars.
Participants who may not benefit from the Roth feature are those expecting Social Security benefits to be their main source of retirement income, participants expecting the same or a lower income tax rate in retirement, and lower income participants who qualify for certain tax credits in current taxable years.
Is there a limit on Roth 403(b) contributions?
Yes, the combined contribution limit for both after-tax Roth contributions and pre-tax 403(b) contributions is set by Internal Revenue Code §402(g). The limit is $17,000 in 2012, plus an additional $5,500 in catch-up contributions if the participant will be age 50 or older at the end of the year. Age 50 catch-up contributions may be designated as Roth contributions. The applicable contribution limits may be increased in later years to reflect cost-of-living adjustments. Participants who make Roth 403(b) contributions within the 403(b) plan may also make Roth IRA contributions to their Roth IRA up to the stated Roth IRA contribution maximums, so long as they meet the Roth IRA eligibility requirements.
Are there any special rules that apply to the Roth 403(b) contributions?
Yes, the following special rules apply to Roth 403(b) contributions:
- Unlike pre-tax 403(b) contributions, after-tax Roth 403(b) contributions do not reduce the participant’s taxable income when they are made and earnings on these contributions are generally not taxable upon withdrawal.
- Plan sponsors must give participants the opportunity at least once per plan year to make designated Roth contributions.
- The qualified distribution criteria applicable to withdrawals of Roth 403(b) amounts require that the Roth account be established for at least 5 years prior to the withdrawal request (measured generally from the first day of the first taxable year during which Roth 403(b) contributions are made) AND the distribution is being taken after the participant reaches age 59 1/2, becomes permanently disabled or dies. If these criteria are not met, the participant will be taxed on the Roth 403(b) earnings.
Can participants roll over their Roth 403(b) contributions to other retirement plans or IRAs?
Once a participant is eligible for a distribution from the Roth 403(b) contribution source, Roth 403(b) accounts may be rolled directly into other designated Roth accounts, including those established in a Roth 401(k), a Roth 403(b), a Roth 457(b) or a Roth IRA. Rollovers of Roth accounts may have an impact on the 5-year holding period described above. Indirect rollovers of Roth 403(b) contributions are problematic and should be avoided.
What is an in-plan Roth rollover?
An in-plan Roth rollover is a distribution from a participant’s non-Roth contribution sources that is rolled over to the Roth contribution source within the same plan at the participant’s direction. After weighing the administrative impacts and special rules associated with in-plan Roth rollovers, plan sponsors can decide whether or not to allow them.
Can participants take loans from their after-tax Roth 403(b) contributions?
Yes, plan sponsors may decide to permit participant loans from Roth 403(b) contribution sources. However, the plan sponsor’s administrative processes related to participant loans may be affected by a decision to allow loans from the after-tax Roth contributions. Plan loans are subject to certain legal requirements and the plan sponsor’s administrative policies.
Can a participant be automatically enrolled in the Roth 403(b) feature?
Yes, a plan sponsor can elect to automatically enroll its employees in the 403(b) plan for purposes of pre-tax and after-tax Roth contributions. The automatic enrollment rules apply and the plan must state how the employer will allocate automatic contributions between pre-tax contributions and Roth contributions.
If the employer makes a matching contribution to the plan, will that contribution also need to be made on a participant’s Roth 403(b) contributions?
The plan’s design will determine whether the employer will make the stated employer contribution on Roth 403(b) contributions. The employer must decide to include or exclude Roth contributions for purposes of making the matching contribution. If matching contributions are made by the employer on the participant’s Roth 403(b) contributions, the matching contributions are made on a pre-tax basis and earnings on the employer-made matching contributions are taxable at distribution.
How is a Roth 403(b) feature established in a 403(b) plan?
A Roth 403(b) feature may be added to a 403(b) plan at any time by adopting a plan amendment prescribing the addition of the Roth 403(b) feature. A thoughtful communications strategy will promote the feature to the participant population so that they understand and feel comfortable using it. Additionally, the payroll file transmitting contribution and other data each payroll period may need to be updated to include a column for Roth 403(b) contributions. Each recordkeeping vendor will have its own administrative requirements for the establishment and operation of a Roth 403(b) feature.
In summary, what are the general requirements associated with establishing a Roth 403(b) feature?
The general requirements for adopting a Roth 403(b) feature are:
- Check with your retirement plan’s recordkeeper to determine how the adoption of a Roth 403(b) feature would impact the administration of the plan;
- Amend the plan document to adopt a Roth 403(b) provision and set rules around how this feature will be administered;
- Make any necessary changes to internal administrative procedures;
- Effectively communicate the addition of the Roth 403(b) feature to participants and employees (plan sponsors may also conduct surveys or solicit feedback from a focus group to determine participant interest in a Roth 403(b) feature);
- Allow participants the opportunity to make designated Roth contributions at least once annually; and,
- Follow the plan’s Roth 403(b) provisions and continue to educate participants about the potential benefits of this feature on an ongoing basis.
Additional requirements may apply depending upon the plan’s design and the vendor’s administrative processes.
Where can I find additional information regarding the adoption of a Roth 403(b) feature?
Your consultant at the Multnomah Group can help you determine whether adopting a Roth feature would be advantageous for your plan.
¹ This FAQ is not intended to be legal advice and should not be construed as such. Information relayed herein is representative of the Multnomah Group’s current understanding of the law. While the Multnomah Group has made every reasonable effort to ensure that the information contained herein is factual, we do not warrant its accuracy. Additionally, this FAQ does not embody a comprehensive legal study, but rather reflects the information most often sought by our clients. As the information contained herein is general in nature, you are urged to contact your legal adviser with questions related to the specific application of these rules to your plan.