Employers sponsoring 401(k) plans may allow participants to make Roth 401(k) contributions on an after-tax basis. When a plan sponsor elects to add a Roth 401(k) feature, Roth 401(k) contributions are recordkeeper separately from other contributions to the plan so that the special rules applicable to Roth 401(k) contributions may be followed. In this way, the Roth 401(k) is not a separate retirement plan, but rather it is a unique feature of the 401(k) plan sponsored by the organization. Participants simply direct desired contributions in their chosen proportions (up to the stated legal maximums) to the pre-tax 401(k) deferral source and/or the after-tax Roth 401(k) 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.
Adopting a Roth 401(k) feature allows participants to contribute after-tax dollars to their retirement plan account. Earnings, if any, on the Roth 401(k) contributions grow on a tax-free basis, meaning that participants will not pay income tax on distributions from the Roth 401(k) 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 401(k) contributions. Unlike Roth IRAs, there are no maximum income limits for Roth 401(k) contributions.
The following types of employees are more likely to benefit from the addition of a Roth 401(k) feature:
Yes, the combined contribution limit for both after-tax Roth contributions and pre-tax 401(k) contributions is set by Internal Revenue Code §402(g). The limit is $17,500 in 2013, 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 401(k) contributions within the 401(k) 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.
Yes, the following special rules apply to Roth 401(k) contributions:
Once a participant is eligible for a distribution from the Roth 401(k) contribution source, Roth 401(k) 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 401(k) contributions are problematic and should be avoided.
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.
Yes, plan sponsors may decide to permit participant loans from Roth 401(k) 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.
Yes, a plan sponsor can elect to automatically enroll its employees in the 401(k) 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.
The plan's design will determine whether the employer will make the stated employer contribution on Roth 401(k) 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 401(k) contributions, the matching contributions are made on a pre-tax basis and earnings on the employer-made matching contributions are taxable at distribution.
A Roth 401(k) feature may be added to a 401(k) plan at any time by adopting a plan amendment prescribing the addition of the Roth 401(k) 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 401(k) contributions. Each recordkeeping vendor will have its own administrative requirements for the establishment and operation of a Roth 401(k) feature.
Additional requirements may apply depending upon the plan’s design and the vendor’s administrative processes.
Your consultant at the Multnomah Group can help you determine whether adopting a Roth feature would be advantageous for your plan.