Roth 401(k) Contributions

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February 15, 2006

In March 2005 the Treasury Department issued proposed regulations that would permit 401(k) plans to allow participants to make Roth contributions to the plan. We expect the proposed regulations will eventually be finalized and that many participants will find the new Roth 401(k) an attractive alternative to saving for retirement.

Roth 401(k) contributions contain features that are similar to a Roth IRA in that contributions are made after taxation and neither contributions nor earnings are subject to tax when distributed. As with a Roth IRA, the earnings on Roth contributions are tax-free. From a plan administrator’s perspective, Roth 401(k) contributions are treated as 401(k) contributions for purposes of plan testing and maximum annual deferral limits (e.g., 2006 limits: elective deferral maximum $15,000; maximum catchup contributions of $5,000).

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With respect to distributions from a Roth 401(k), the same qualified contribution rules for Roth IRAs apply (e.g., participants must have started contributing to the Roth at least five years before the initial distribution). Separating participants may roll over their Roth 401(k) contributions to a Roth IRA or another employer’s Roth 401(k).

Employers who wish to include this new feature may do so beginning January 1, 2006 by amending their plans, establishing internal payroll practices and communicating this new feature to plan participants. The following are some items to consider:

  • The Roth 401(k) essentially requires plans to create another “subaccount” or “bucket” in which Roth 401(k) contributions and earnings are reported, same manner in which plan administrators currently track matching contributions, profit-sharing contributions and participant deferrals.
  • Payroll systems will need to be prepared to treat Roth “after-tax” contributions differently for purposes of tax withholding and W-2 reporting.
  • Roth contribution elections must be made prospectively and are irrevocable until the participant submits a new election form. Employers may wish to evaluate their current practices with respect to permitting changes to deferral elections

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