The Rules of the Roth

The Rules of the Roth

| September 21, 2017

Each of your workers has a unique story, and some demographics in particular may benefit from Roth options in the company’s retirement plan. Young workers, employees in lower tax brackets, and even  highly compensated employees may want to consider Roth, in which contributions are deducted from wages after payroll taxes are factored in. They do not reduce a participant’s taxable income in the year he  or she contributes in a plan.

Under the expanded Roth conversion rule, which went into effect in 2013, participants can convert any of their plan assets to a Roth account within the plan, even if they are not eligible for distribution. Plan sponsors should consider whether their employees would be interested in this option, as it may provide tax benefits and help with retirement readiness. Enlist the help of your advisor to determine if your plan could benefit from adding or expanding Roth options.

A Brief History of Roth

Since 2006, retirement plans have included an option for designated Roth contributions (referred to as Roth contributions here). In 2010, retirement plans that allowed Roth contributions also began allowing in-plan Roth conversions, but the option was only available to participants who were eligible for a distribution — such as those who were 59½ years old or whose employment had ended.
Effective January 1, 2013 — under the American Taxpayer Relief Act of 2012 (ATRA) — Congress expanded the Roth conversion rule to allow participants to convert any of their plan assets to a Roth account within the plan even if they are not eligible to take a distribution. As a result, many more employees are able to pay taxes on their retirement savings immediately to avoid paying them when they retire. Congress estimates that an additional $12 billion in tax revenue could be generated over the next 10 years as more participants use this opportunity, according to the Joint Committee on Taxation.
After many questions and concerns about the new provision, the Internal Revenue Service issued Notice 2013-74 in December 2013. When adding these in-plan Roth options, be sure to consult the most recent guidance from the IRS and work with your advisor to ensure you have complied with current rules.

Is Your Plan Eligible?
The in-plan Roth conversion rules expanded by ATRA say that to be eligible, a plan must:
ƒ Be a 401(k), 403(b) or governmental 457(b) plan (any plan that allows Roth contributions).
ƒ Be amended to allow the expanded in-plan Roth conversion option.
ƒ Be amended to add Roth contributions (if it does not currently) before the in-plan conversion option can be incorporated.
Participants are eligible to convert their assets, regardless of whether they have a distribution-triggering event. Spouse beneficiaries and former spouses who have a plan account balance may also convert their assets within the plan. 

Creating An Action Plan 

If you determine that Roth features are an attractive option for your employees, your advisor can assist you in adding the plan features.

Step 1

Analyze Employee Demographics
The first step is determining whether your employee base could benefit from Roth contributions and in-plan conversions. They may be appealing options for many of your employees, particularly those who:
ƒ Want to diversify the tax status of their retirement savings by creating tax-free retirement income through a Roth account.
ƒ Anticipate a substantial increase in the value of their investments, and as a result want to pay taxes on their lower account balance now.
ƒ Are currently in a lower tax bracket and want to pay the current tax rate on their retirement savings to prevent paying higher taxes in the future.
ƒ Are highly compensated and have not been able to contribute to a Roth IRA because of earned income restrictions.
ƒ Want an estate-planning strategy that includes tax-free assets to beneficiaries after the participant’s death.
ƒ Are interested in reducing their RMDs after age 70½ by rolling over their Roth plan accounts into a Roth IRA.
Some employees may want to make both pretax and Roth contributions each year — these contributions will be combined when calculating annual contribution limits. For 2015, the annual contribution limit is $18,000, up from $17,500 in the previous two years. The catch-up contribution limit (for employees age 50 and older) is $6,000 in 2015. 

Step 2

Create an Education and Communication Strategy    

Once you have examined your employee demographics, it’s time to develop an implementation plan that includes education and communication strategies. Participants will need to be aware of their options, as well as the benefits and potential tax consequences of Roth contributions. Calculators and other tools can help participants determine whether pretax deferrals or Roth contributions are better for them. Ask your retirement plan advisor or service provider about which tools are best to help participants understand the tax implications of Roth contributions or an in-plan conversion. Participants considering an in-plan Roth conversion should consult with a tax advisor to discuss all the potential tax implications. Tax advisors may also help participants with a strategy for their Roth transactions to minimize the tax impact.

Step 3

Determine Your Administrative Duties
The next step is assessing the administrative responsibilities associated with Roth contributions or an in-plan conversion. Your advisor can also help you work with the recordkeeper and payroll advisor to determine how they administer Roth features. They can inform you of costs and services that may be required to add this plan feature. As a plan sponsor, you should be aware of any additional administrative duties associated with adding Roth features, and inform all necessary staff members.

Step 4

Amend the Plan Document
When adding a Roth deferral feature or expanding in-plan Roth conversion, the plan document must be adjusted accordingly. Collaborate with your plan document expert to create the appropriate amendments to change your plan’s features.

The expanded in-plan Roth conversion rule enacted by Congress in 2013 allows participants to convert any of their plan assets to a Roth account within the plan, even if they are not eligible for distribution. Your employees may be interested in this option, particularly if they are young and want to pay the current tax rate on their retirement savings in anticipation of higher tax rates in the future. Highly compensated workers may also benefit from this option if they were not able to contribute to a Roth IRA in the past because of earned income restrictions.
If expanded Roth options seem like a good fit for your employee base, it’s important to develop a plan to educate workers about the potential benefits and tax implications of Roth contributions. For example, Roth contributions may enhance retirement readiness by helping participants diversify the tax nature of their retirement income. But employees must also be aware of possible tax implications — the increase in taxable income resulting from Roth contributions may move participants into a higher income tax bracket. Plan sponsors can work with advisors to create an education plan surrounding the expanded Roth options. In addition, it’s important for plan sponsors to assess the new administrative responsibilities that come with the change in plan features. They will also need to work with a plan document expert to reflect changes in the plan.

Click Here for PDF Version: The Rules of Roth

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