Roth 401 (k) Plans
by Gregory D. Willett and R. Tyler Hand

Introduction
Beginning in 2006, Section 401(k) plans may include a “qualified Roth contribution program,” a feature that allows participants, regardless of income, to make after-tax contributions of all or a portion of the elective deferrals that they would otherwise make to a traditional 401(k) plan.  By making after-tax contributions, future withdrawals by the participant from the Roth 401(k) will be tax-exempt from income tax.  With our clients in mind, we have outlined several of the main issues that should be considered when evaluating whether to incorporate a Roth 401(k) plan into your existing plan. 

Responsibilities of Employer
Designated Roth contributions are treated as any other 401(k) plan elective deferral or 403(b) annuity plan salary deduction contribution (except, however, that Roth contributions are includible in the participant’s income). Thus, under 401(k) plans, designated Roth contributions are treated as elective deferrals under the 401(k)(3) nondiscrimination test. 

Separate Roth Accounts.  All 401(k) or 403(b) plans that adopt the qualified Roth contribution feature will be required to establish a separate “designated Roth account” for each participant’s “designated Roth contributions,” and maintain separate recordkeeping for each account.  This recordkeeping will require that all gains, losses and other credits or charges be separately allocated on a reasonable and consistent basis to the participant's designated Roth account.

Required Plan Amendment.   Any organization planning to adopt the designated Roth account feature for its 401(k) or 403(b) plan will be required to amend its existing plan document.

Effect on Plan Participants
Income Tax Consequences.  Although contributions to a “designated Roth account” are included in the participant's gross income, all “qualified distributions” are exempt from income tax upon receipt.  Also, distributions from a designated Roth account are not aggregated with other distributions from the plan for purposes of determining the taxable portion of each payment. Therefore, “qualified distributions” from designated Roth accounts permanently avoid income taxes because earnings are distributed tax-free.

Qualified Distributions.  A “qualified distribution” may be made (1) after the five-year nonexclusion period which begins with the first year in which the participant makes a designated Roth account contribution and (2) when a participant: (a) reaches age 59; (b) is disabled; or (c) dies.

Annual Limits on Contributions.  Because designated Roth contributions are treated as elective deferrals, they are subject to the annual Section 402(g) limit of $15,000 for 2006 ($20,000 for individuals who will have reached 50 during the year).  This limit applies to the sum of the designated Roth contributions and the amount of elective deferrals that are not designated Roth contributions.  

Contributions in excess of the limit on elective deferrals that are attributed to designated Roth contributions may be subject to tax upon distribution (even though contributions were made after-tax) – unless the excess contributions are distributed in a timely manner. Furthermore, contributions in excess of the limit based on the nondiscrimination rules may be subject to a 10% excise tax if not appropriately corrected. 

Minimum Distribution Requirements.  Designated Roth accounts, unlike Roth IRAs, are subject to the minimum required distribution rules during a participant’s lifetime (e.g., at the later of age 70½ or retirement). 

If you have any questions about this article or need more information about a qualified Roth contribution program, please do not hesitate to contact a member of our Taxation & Estate Preservation Group.