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Roth 401k - Rules and features proposed by the IRS

Posted on: 20th Dec, 2005 12:42 am
The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) proposed in the year 2001 included a provision in the 401k plan that would allow participants of the plan to designate a part or the entire contribution as the Roth contribution. This will come into effect from January 2006 and the provision will remain till the end of 2010.

A Roth 401k Plan will include after-tax contributions unlike a general 401k plan which is concerned with pre-tax contribution. Taxes will be deducted from the participant's pay and then contributions will be made from the salary. But if the participant withdraws a certain amount from the total contribution after 59 and 1/2 years of age or due to death or disability, then he will not have to pay taxes under the condition that the distribution occurs after 5years of contribution.

The IRS has come up with some rules and regulations regarding the Roth 401(k) Plan. In order to designate a part or whole of the 401(k) Plan as the Roth contribution, a participant must satisfy the following criteria.
  • The participant's contribution to the Roth 401(k) plan is not reversible, that is, once it is designated as Roth contribution, it cannot be changed.

  • Any employer offering a Roth 401(k) Plan has to consider the contributions as wages subject to the withholding requirements at the time the participant will receive the total accumulated amount.

  • The participant should use a separate account for the Roth contributions and the earnings and losses on the total amount.

  • A 401(k) Plan must have provision to allow for the Roth contributions.
The designated Roth contributions must comply with the rules applied in case of pre-tax contributions under a 401(k) Plan.
  • The Roth contributions must follow the restrictions on non-forfeitability and distribution applied to 401(k) Plan contributions.

  • The Roth contribution must be included within the regular 401(k) Plan contribution so that these add up to the annual contribution limit which is equal to $15,000 for the year 2006. A participant cannot contribute $15,000 to a regular 401(k) Plan and another $15,000 to a Roth 401(k) Plan.

  • The Roth contributions must be included within the pre-tax contribution (for 401k Plan) which is considered for the Actual Deferral Percentage (ADP) nondiscrimination test.

  • The Roth contributions cannot be withdrawn before 59 and ½ years except for conditions of financial hardship. The contributions should follow the minimum distribution rules of 401(k) Plan.
All participants can make the Roth 401(k) contributions regardless of their gross income. This is where the Roth 401(k) plan differs from a Roth IRA which cannot be used by higher income employees. Roth 401(k) contributions can be rolled over to a Roth IRA provided the participant no longer remains an employee. The amount rolled over to the Roth IRA will not be subject to the minimum distribution rules as followed in a 401(k) plan.

A Roth 401(k) plan may have certain benefits but whether a participant would designate a part of his 401(k) contribution as Roth contribution or continue with pretax contribution, depends on his effective tax rate during his retirement period – whether the tax rate during distribution is higher than at the time of contribution and also the subsequent tax laws.

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I was going through the information you have given above and i find it quite helpful. But can you tell me what is IRS? Is it a government agency?
Posted on: 20th Dec, 2005 03:19 am

Internal Revenue Service is an agency of the treasury department under the US government. It is headed by the commissioner of internal revenue. Different functions of IRS are issuing interpretations of tax laws and auditing tax returns.

Merry Christmas :D

Posted on: 20th Dec, 2005 03:25 am
Under the IRS regulations, any qualified distribution from a designated Roth contribution account, including earnings, will not be included within the income of the participant availing the plan benefits. The qualified distribution will not be subjected to the 10% tax on early withdrawal in case of a general 401k Plan.

But when a distribution from a designated Roth contribution cannot be taken as a qualified distribution, then it will be included within the participant's income. The distribution and will be subjected to 10% taxes on early withdrawals unless thee are some exceptions.

A qualified distribution must satisfy the following criteria:
  • The distribution has to be made after the first 5 years of the contribution during which the participant has to pay taxes on withdrawal.

  • The distribution should start when the participant is 59 and 1/2 years of age or older than that. The participant can also withdraw cash on account of death or disability.
Posted on: 20th Dec, 2005 10:54 pm
Can I rollover a IRA custodial account to a Roth IRA custodial account?
Posted on: 10th Nov, 2006 01:19 pm
Hi Fred,

Yes the rollover is quite possible if you are eligible for such a conversion.

Some of the eligibility conditions are like:
  • If your filing status is married filing separately then you do not qualify unless you lived apart for the entire year.
  • If your modified adjusted gross income is greater than $100,000, the rollover will not be possible.
  • You can not directly roll from an employer plan to a Roth IRA, although you may be able to roll to a traditional IRA and then convert to a Roth IRA.
  • If you have inherited an IRA from a person other than your spouse then also the conversion is not possible.
Let me add that you can convert a traditional IRA to a Roth IRA even if you had made a rollover within the previous 12 months. Also, if you are otherwise eligible you can convert part of a traditional IRA to a Roth IRA.

Posted on: 10th Nov, 2006 05:10 pm
Hi Fred,

You can roll over a part or whole your IRA into a Roth IRA under the following conditions:
  • Your adjusted gross income is no more than $100,000

  • You are not a married individual filing a separate return.
You will have to pay income taxes on the amount rolled over. However, if you have made non-deductible contributions to your IRA, then a certain part of the rollover will not be taxable.

Hope this is going to help you. For any other query, feel free to contact us.


Posted on: 10th Nov, 2006 10:33 pm
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