United States: IRS Issues Notice On Expanded In-Plan Roth Conversion Option

Last Updated: December 19 2013
Article by Brian J. Dougherty and Timothy Kennedy

Guidance confirms that plan sponsors have flexibility in designing and implementing a feature that allows participants to convert vested pre-tax balances to after-tax Roth balances.

On December 11, the Internal Revenue Service (IRS) issued Notice 2013-741 to provide guidance on a change in law that permits sponsors of 401(k), 403(b), and governmental 457(b) plans to offer participants in-plan Roth conversions of pre-tax amounts not yet eligible for distribution. The change, enacted early in 2013 as part of the American Taxpayer Relief Act (ATRA),2 expanded section 402A(c)(4) of the Internal Revenue Code of 1986, as amended, (the Code) by extending an existing, limited in-plan Roth conversion option to all vested amounts under eligible plans, including those amounts not yet eligible for distribution.

Notice 2013-74 confirms that plan sponsors that implement an in-plan Roth conversion option generally may limit the types of vested pre-tax contributions that participants can convert, may specify the frequency with which participants can elect to make in-plan conversions, and may discontinue such in-plan conversion programs. The notice further provides special time frames during which plan sponsors may adopt amendments related to in-plan Roth conversion features as well as other guidance regarding in-plan Roth conversions of both distributable and nondistributable amounts.

What is an in-plan Roth conversion?

Sponsors of 401(k) plans, 403(b) plans, and governmental 457(b) plans may offer participants the option to make in-plan Roth conversions (referred to as "in-plan Roth rollovers" in Notice 2013-74), in which they transfer assets from their non-Roth accounts to a designated Roth account in the same plan. An in-plan Roth conversion of non-Roth pre-tax dollars to Roth after-tax dollars causes the converted amounts to be taxed in the year of the conversion, while generally allowing for future qualified tax-free distributions of converted amounts and any accumulated earnings, so long as the account has been in place for at least five years and the distribution satisfies certain other restrictions.

Which pre-tax amounts can be converted to Roth after-tax amounts?

All vested assets in an eligible plan may now be converted under a plan's in-plan Roth conversion feature, including pre-tax elective deferrals, employer matching contributions, and nonelective employer contributions. Prior to the change in law under ATRA, the in-plan Roth conversion option was limited to amounts that were otherwise distributable under tax law. ATRA extended the in-plan Roth conversion option to amounts not otherwise distributable from a plan. Notice 2013-74 clarifies that only vested amounts may be converted.

Notice 2013-74 also makes clear that plan sponsors may restrict the types of vested contributions eligible for an in-plan Roth conversion and the frequency with which participants can make in-plan Roth conversions, provided that such restrictions do not operate to discriminate in favor of highly compensated employees. The notice also explains that the right to make in-plan Roth conversions is not a protected benefit and thus can be discontinued subject to the general nondiscrimination rules.

What guidance does Notice 2013-74 offer on the administration of in-plan Roth conversions?

Withholding and Tax Consequences

Notice 2013-74 provides that amounts converted under an in-plan Roth conversion option are not subject to income tax withholding and accordingly warns that employees who make in-plan Roth conversions may need to increase their withholding rates or make estimated tax payments to cover the income tax liability resulting from the conversion. For plan accounts holding employer securities, the notice indicates that an in-plan Roth conversion will be treated as a distribution for the purpose of determining whether a participant qualifies for special tax treatment of the net unrealized appreciation on employer securities under Code section 402(e)(4)(B).

Although the IRS characterizes in-plan Roth conversions as in-plan "rollovers" from non-Roth to Roth accounts, Notice 2013-74 explains that plan administrators do not need to provide Code section 402(f) notices regarding the tax consequences of rollover distributions to employees who elect to make in-plan Roth conversions of otherwise nondistributable amounts.

Maintenance of Distribution Restrictions

The notice also explains that distribution restrictions applying to a pre-tax amount before it is converted to a Roth after-tax amount under an in-plan Roth conversion feature will continue to apply to the converted amount. The notice acknowledges that, to simplify recordkeeping, a plan sponsor may wish to restrict eligibility for in-plan Roth conversion only to otherwise distributable amounts so that separate accounting for different converted amounts, subject to different distribution restrictions, is not required.

Determination of the Five-Year Period for Qualified Roth Distributions

Distributions of Roth amounts and accumulated earnings ordinarily are tax free if they are "qualified distributions" from a Roth account made more than five taxable years after the first year the participant contributed to the Roth account and if they satisfy certain other restrictions. For the purpose of determining when a subsequent distribution is "qualified," Notice 2013-74 confirms that, if an in-plan Roth conversion is a participant's first contribution to a designated Roth account in the plan, the five-taxable-year period begins on the first day of the taxable year in which the in-plan Roth conversion was made.

Treatment of Converted Excess Deferrals and Contributions

The notice provides further guidance on the treatment of amounts converted under an in-plan Roth conversion feature that are later found to be excess deferrals under the Code's individual deferral limits or excess contributions under the Code's nondiscrimination rules. The notice explains that, if an employee converts all pre-tax amounts to Roth after-tax amounts through an in-plan Roth conversion feature and the amounts are later found to be excess deferrals or contributions, the excess amounts must be distributed from the Roth account even if the amounts were considered otherwise nondistributable at the time of the in-plan Roth conversion.

Effect on Determination of Top-Heavy Status

The notice provides that an amount converted in an in-plan Roth conversion (which the notice refers to as an "in-plan Roth rollover") is treated as a "related rollover" amount that is considered in calculating participant account balances under the rules for determining whether a plan is a "top heavy" plan that favors key employees.

When must a plan sponsor adopt an amendment providing for in-plan Roth conversions of otherwise distributable amounts?

Under Notice 2013-74, a 401(k) plan or governmental 457(b) plan generally can immediately begin offering in-plan Roth conversions, provided that a plan amendment for the in-plan Roth conversion feature is adopted by the last day of the first plan year in which the amendment is effective or December 31, 2014, if later. The notice also permits sponsors of safe harbor 401(k) plans to begin immediately offering such conversions, even midyear, in 2013 and 2014. For a calendar-year safe-harbor plan, the amendment to provide the conversion option starting midyear 2013 or 2014 must be adopted by December 31, 2014. A 403(b) plan sponsor that has timely adopted a written plan document may offer in-plan Roth conversions immediately as well and must adopt an amendment by the end of the ongoing remedial amendment period. The notice indicates that the IRS expects the end of the 403(b) plan remedial amendment period to be more than a year from the date of the notice.

This special amendment period applies to the implementation of in-plan Roth conversion features of both distributable and otherwise not distributable amounts as well as to the addition of Roth contribution features and provisions to accept Roth rollover contributions.

What are the impacts and what next steps should plan sponsors take?

By broadening the pool of eligible assets, the new in-plan Roth conversion rule provides participants with a much greater opportunity to convert pre-tax dollars to Roth after-tax dollars. This is especially attractive for those individuals currently in lower tax brackets who have assets outside of the plan that can be used to pay taxes on the conversion.

Plan sponsors have the option, but not the obligation, to amend their eligible plans to add or expand the in-plan Roth conversion feature. A plan is not required to offer the expanded option, for example, simply because it already offers an in-plan Roth conversion feature permitted under the prior rules or accepts ongoing Roth contributions. Plan sponsors that have adopted or will adopt the feature have the ability to limit the types of contributions eligible for in-plan Roth conversion and to discontinue the conversion program. The new rule is permissive rather than mandatory and will therefore require a plan amendment to be effective. Plan sponsors that already have been offering in-plan Roth deferrals generally will have at least until the end of 2014 to adopt a plan amendment.

Footnotes

1. View Notice 2013-74 here.

2. For more information on this change under ATRA, view our January 30, 2013 LawFlash, "Fiscal Cliff Legislation Expands In-Plan Roth Conversion Opportunities," available here.

This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.