Roth 401(k) Knowledgebase
Compliance and Recordkeeping
Plans that include a Roth 401(k) feature have specific plan qualification, recordkeeping, and administration (compliance) requirements as discussed below.
Roth 401(k) Elective Deferral Treatment Elective deferrals made to a Roth 401(k) account are treated the same as pre-tax 401(k) deferrals for all compliance and testing purposes, including:
Separate Accounting The Roth 401(k) account must be separate and distinct from the pre-tax 401(k) or any other participant accounts including voluntary after-tax contribution accounts. Separate recordkeeping of the cumulative contributions (the “principal” or “basis”) and earnings facilitates distributions in a manner that is distinct to Roth 401(k) accounts. See Distinctions between Roth 401(k) and Roth IRA
This recordkeeping requirement (tracking the principal amount of the contribution) is the same as is currently necessary to determine the maximum pre-tax 401(k) hardship distribution; however, administration systems must have the available fields to add the Roth 401(k) account. The Roth 401(k) account must have separate fields for contributions and interest to facilitate determination of availability for distributions, compliance testing, and distribution reporting purposes while also having the capability to combine the fields for year-end reporting.
Ordering Rules Administrative procedures, and possibly plan language, are required to determine the order for refunding pre-tax and Roth 401(k) contributions (and catch-up contributions) with regard to the taxation of corrective distributions resulting from ADP testing failures, refunds of contributions that exceed the §402(g) limit, and deemed distributions resulting from loan defaults.
The regulations provide that the HCE participant may designate the order in which refunds are made from each respective money type (pre-tax first, Roth first, or both proportionately; also see discussion under “Forms”). As a practical matter, ordering rules are typically specified in the plan document to facilitate system programming and mitigate processing errors.
Distributions for Loans, In-service, Hardship and QDROs The money type from which distributions occur impacts the taxation of the distribution. Therefore, policies and forms that affect these distributions must address the distinction between Roth and pre-tax accounts. Distributions specified from a Roth account may result in a significantly different outcome than anticipated dependent on the tax status (qualified or nonqualified) of the distribution.
Refund of Excess Contributions If a plan’s ADP Test fails, HCEs may receive a refund representing the excess contribution. The principal amount of any Roth 401(k) contribution refund is not taxable. However, any investment gains may be, if that portion of the distribution would not satisfy the rules to qualify for tax-free status. If the HCE contributes to both the Roth and the pre-tax accounts, the regulations permit the HCE to designate the money type from which the refund is processed. However, as previously stated, as a practical matter, plans typically designate ordering rules for refunds. The same rules apply to refunds of excess aggregate contributions if a refund to cure a failed ACP test includes elective deferrals.
Automatic Rollovers If a plan contains mandatory cash out provisions for account balances exceeding $1,000, an automatic rollover to an IRA is required when a participant’s account balance is between $1,000 and $5,000, and the participant has not made an affirmative election to either roll over or take a taxable distribution. If the participant’s account consists of both Roth and pre-tax monies, each respective money type must be rolled over into the appropriate type of IRA. If the total account balances equals $1,001 but the amount from each respective money type is less than $1,000, the plan administrator must be mindful that certain IRA custodians do not accept small amounts that are below the threshold stated in their service agreement.
Automatic Enrollment If the plan contains an automatic enrollment feature, forms and procedures may need to be modified if the automatic enrollment involves Roth 401(k) contributions.
Payroll System Issues
Plan Amendments Adding the Roth 401(k) contribution feature requires an interim amendment by the end of the plan year in which the option is first effective. Detailed plan amendments are required when the plan is reviewed for EGTRRA.
Participant Disclosure The new Roth 401(k) feature must be included in all required participant disclosures as discussed below. In addition to the required disclosures, employer/plan sponsors should consider providing additional written communications and holding employee meetings to explain the benefits and features of the Roth 401(k) to existing participants as well as future new plan participants.
Summary Plan Description (SPD) The
plan’s SPD (or amendment to the SPD, i.e., the summary of material
modifications, or SMM) must provide an explanation of the Roth 401(k)
eligibility requirements, tax treatment of contributions and earnings,
contribution limits, withdrawal restrictions, and any applicable procedural
402(f) Notice Participants who are entitled to receive a distribution that is eligible for rollover must be provided written notice regarding the participant’s right to roll the distribution over to an eligible retirement plan and any tax implications. If the plan has a Roth 401(k) feature, the notice must reflect those issues that are unique to rollovers from Roth 401(k) accounts. The IRS is expected to issue an updated version of the model IRC §402(f) notice reflecting the appropriate changes for plans with a Roth 401(k) feature before January 1, 2006. Sample Model 402(f) Notice (Plans with Roth 401(k) Account)
Forms Depending on the nature of the action required, most, if not all, of the plan administrative forms need modification.
Final Roth 401(k) Regulations