The ERISA consultants at the Columbia Management Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with a financial advisor in Michigan is representative of a common scenario involving designated Roth contributions in a 401(k) plan. The advisor asked:
Do the modified adjusted gross income (MAGI) levels that apply for determining eligibility to contribute to a Roth IRA apply to a 401(k) plan participant for determining eligibility to make designated Roth contributions?
Highlights of Discussion
- The short answer is “no” — 401(k) plan participants who have the option to make designated Roth contributions according to the terms of the plan are not restricted because of their MAGI level. That means that someone who cannot make a Roth IRA contribution because of his or her MAGI level, might still be eligible to make 401(k) designated Roth contributions. What’s more, the per-individual annual limit on designated Roth contributions is higher than the annual limit for Roth IRA contributions.
- The Economic Growth and Tax Relief Reconciliation Act of 2001 introduced designated Roth contributions for 401(k) and 403(b) plans, effective for years beginning on or after Jan. 1, 2006. The Small Business Jobs and Credit Act of 2010 allows governmental 457(b) plans to offer designated Roth contributions, effective for years beginning on or after Jan. 1, 2011.
- If the plan includes a designated Roth contribution feature, as long as the individual meets the plan’s general eligibility requirements to participate, he or she can choose to make designated Roth contributions.
- A 401(k) plan participant’s pre-tax salary deferrals and designated Roth contributions combined are limited for the year to the IRC §402(g) limit of $17,500 for 2014 (or $23,000 if the participant is age 50 or older). For 2015, those limits are $18,000 and $24,000 respectively.
- Designated Roth contributions are treated the same as pre-tax elective deferrals for many purposes, including the following.
- Included in the individual’s annual IRC §402(g) limit
- Included in the individual’s annual IRC §415 limit for all contributions (i.e., maximum of $52,000 or $57,500 if including catch-up contributions for 2014, and $53,000 or $59,000 with catch-up contributions for 2015)
- Included in nondiscrimination testing
- Subject to required minimum distributions
- Excluded for employer contribution deductibility purposes under IRC §404
- Subject to nonforfeitability and distribution restrictions
- Distributions of designated Roth contributions may be fully tax- and penalty-free if:
- the distribution is made after attaining age 59-1/2, death or disability (NOTE: there is no first-time home purchase qualifier as there is with Roth IRAs); and
- five years have elapsed from when the participant first contributed to the designated Roth contribution account.
Conclusion
If the plan allows, eligible participants can contribute designated Roth contributions — in combination with, or instead of, pre-tax salary deferrals — regardless of their MAGI levels. Making designated Roth contributions is a great way for investors to establish a source of after-tax assets if their MAGI does not allow them to contribute to Roth IRAs.
The Columbia Management Retirement Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC, a third-party industry consultant that is not affiliated with Columbia Management. For informational purposes only. Please consult a tax advisor or attorney for specific tax or legal needs. © 2014 Columbia Management Investment Advisers, LLC. Used with permission.
