On September 27, 2010, President Obama signed the Small Business Jobs and Credit Act of 2010 (the “Small Business Jobs Act” or the “Act”). The bill includes several provisions affecting the use of Roth IRA features in certain plans. The first permits Roth contributions to 457(b) plans maintained by state or local governments, a feature that is currently limited to 401(k) and 403(b) plans. The second permits certain amounts in 401(k), 403(b), and governmental 457(b) plans to be converted to Roth accounts within the same plan (i.e., an “in-plan” conversion option). The in-plan Roth conversion option became effective upon enactment, while the Roth 457(b) option takes effect in 2011.
Roth 457(b) Contributions
Prior to the Act, Roth contributions could be made only to 401(k) and 403(b) plans. Beginning on January 1, 2011, governmental 457(b) plans may also adopt a Roth contribution feature, thereby allowing participants in such plans to designate that some or all of their elective deferrals be treated and separately accounted for as after-tax, Roth contributions.
In-Plan Roth Conversions
Under the Act, participants in a tax-favored plan that has a Roth contribution feature may “roll” non-Roth amounts to a designated Roth account maintained within the same plan, and this “rollover” will be treated as a taxable conversion. However, there are some significant limitations on this “in-plan conversion” option.1
Most importantly, a plan that does not otherwise have a designated Roth program is not permitted to establish Roth accounts solely to accept these “rollover” contributions. In other words, a plan wishing to implement the changes under the Act must be amended to allow its participants to designate any elective contribution as a designated Roth contribution2 in lieu of making a pre-tax elective contribution.
Favorable tax rules apply to conversions made before the end of 2010. For conversions made in 2010, participants will be able to amortize their conversion tax realized in equal amounts in 2011 and 2012. Unfortunately, this does not leave much time for participants to take advantage of this valuable deferral opportunity. Thus, plan sponsors should act quickly to draft and disseminate the appropriate participant communications.
Employers who sponsor 401(k) or 403(b) plans with Roth contribution features should determine as soon as possible whether to allow in-plan Roth conversions and, if so, whether to make that feature available before the end of 2010. If a plan sponsor wants to allow these rollover contributions (i.e., an “in-plan” conversion option), the plan must be amended to reflect this plan feature. It is intended that the IRS will provide employers with a remedial amendment period that allows employers to offer this option to its employees for distributions during 2010 and the have sufficient time to amend the plan to reflect this feature.
Additionally, governmental employers that sponsor 457(b) plans may want to consider adding both a Roth contribution feature and an in-plan Roth conversion feature starting in 2011.3
1 These limitations include: (i) the plan must be a 401(k), 403(b), or, after January 1, 2011, a 457(b) plan that includes a Roth contribution feature; (ii) this conversion option is limited to amounts that are “eligible rollover distributions;” and (iii) the plan must be amended to provide for this option.
2 This requires the maintenance of separate accounts for “designated Roth contributions.”
3 See section 401(b), Treas. Reg. sec 1.401(b)-1, and Rev. Proc. 2007-44, 2007-2 CB 54.
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This communication expresses our opinion and does not represent a legal interpretation, opinion, or other legal advice since we are not attorneys. Should you wish to rely upon this information for matters requiring a legal opinion, you should seek the expert advice of an attorney who is qualified to render legal opinions on such matters.