Case of the Week: Federal Withholding and In-Plan Roth Conversions

The ERISA consultants at the Learning Center Resource Desk, which is available through Columbia Threadneedle Investments, regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with an advisor in Maryland is representative of a common inquiry involving an in-plan Roth conversion in a 401(k) plan. The advisor asked:

“How do the federal withholding rules apply to an in-plan Roth conversion in a 401(k) plan?” 

Highlights of Discussion

The federal withholding rules for in-plan conversions to a designated Roth account in a 401(k) plan are similar to the rules that generally apply for eligible rollover distributions that are rolled over directly to another eligible plan versus rolled over indirectly (i.e., within 60 days) (Internal Revenue Code Section 3405). The IRS has provided specific guidance for in-plan Roth conversions in Notice 2013-74,  Q&A 4.

If the conversion of assets in-plan is done as a direct rollover to the designated Roth account, and the participant does not receive any of the assets, the plan sponsor should not withhold taxes. Neither can a participant request voluntary withholding under IRC Sec. 3402(p). Since a conversion is generally a taxable event, a plan participant making a direct in-plan Roth conversion may need to increase his or her withholding or make estimated tax payments to avoid an underpayment penalty from the IRS.

In contrast, if a plan participant receives a distribution in cash from the plan, the plan sponsor must withhold 20% federal income tax even if the participant later rolls over the distribution to a designated Roth account within 60 days.

Conclusion

Since plan sponsors do not apply federal income tax withholding to a direct in-plan Roth, a plan participant may need to increase his or her withholding or make estimated tax payments to avoid an underpayment penalty from the IRS.

The Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC (RLC), a third-party industry consultant that is not affiliated with Columbia Threadneedle. Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Columbia Threadneedle does not provide tax or legal advice. Consumers consult with their tax advisor or attorney regarding their specific situation.

Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Columbia Threadneedle.

Columbia Threadneedle Investments (Columbia Threadneedle) is the global brand name of the Columbia and Threadneedle group of companies.

©2017, Columbia Management Investment Advisers, LLC. Used with permission.

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