The ERISA consultants at the Retirement Learning Center Resource regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with a financial advisor from New York is representative of a common inquiry related to designated Roth contributions in a 401(k) plan. The advisor asked:
“Can you explain how the 5-year clock applies to Roth 401(k) contributions?”
Highlights of the Discussion
Distributions of Roth 401(k) contributions (i.e., designated Roth contributions) can be taken tax- and penalty-free if the participant meets certain conditions for a “qualifying distribution.” A qualifying distribution is one that is made after a 5-taxable-year period of participation (“the 5-year clock”), and the participant has attained age 59½, has become disabled or, in the case of a beneficiary, following the participant’s death.
The 5-year clock begins on the first day of the participant’s taxable year in which he or she first makes designated Roth contributions to the plan. If the first Roth contribution is a rollover of designated Roth contributions from another 401(k) plan, the starting of the 5-year clock depends on whether the rollover is direct or indirect.
If the participant completes a direct rollover from a designated Roth account under another plan, the 5-year period is deemed to have begun on the first day of the taxable year that the employee made Roth 401(k) contributions to the other plan. In contrast, an indirect rollover contribution restarts the 5-year clock under the receiving plan for a participant who has made no prior Roth 401(k) contributions to the receiving plan (Treasury Regulation 1.402A-1, Q&A 4).
Conclusion
Since the 5-year clock for determining a tax-free qualifying distribution of Roth 401(k) contributions begins on the first day of the participant’s taxable year in which he or she first makes a designated Roth contribution to the plan, it may be wise for a participant—if he or she has the option—to designate even $1 of elective contributions as a Roth 401(k) contribution right away in order to start the ticking of the 5-year clock. And if a participant is rolling over Roth 401(k) contributions, a direct rollover is the only way to avoid restarting the 5-year period.
Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Consumers should consult with their tax advisor or attorney regarding their specific situation.
©2019, Retirement Learning Center, LLC. Used with permission.
