The final word on Roth 401(k) plan distributions

Although Roth 401(k) deferrals were allowed as early as January 2006, questions on the taxation of distributions from these accounts weren’t answered until the IRS issued its final regulations. Some highlights of the final regulations address:

The five-year period. To maintain a distribution’s qualified (tax free) status, a participant cannot take a Roth 401(k) distribution before the end of the fifth consecutive year following the first day of the year in which the participant made the first Roth 401(k) deferral to the plan. Plan administrators will have to track this five-year period to make sure the participant has the Roth account in the plan for the required time. Roth 401(k) deferrals that are returned in full due to failed testing don’t start the period.

Rollovers. A rollover from a Roth 401(k) account that includes nontaxable amounts must be direct. The distributing plan must report the five-year period start date to the new plan. The receiving plan must permit Roth deferrals and satisfy separate accounting requirements. A participant’s Roth accounts don’t need to be kept separate; the earlier of the five-year periods applies to all.

If a Roth 401(k) account is first distributed to the participant, only the taxable portion can be rolled (within 60 days) into another plan account, with the five-year period starting over. The receiving plan administrator must report the acceptance of this rollover to the IRS.

Participants can roll over a Roth 401(k) plan account directly or indirectly to a Roth IRA, regardless of the participant’s income. Unless a Roth IRA was previously established, a new five-year period begins. A Roth IRA can never be rolled to a Roth 401(k) plan.

Hardship distributions. Although the distribution may not necessarily be qualified, plans can allow for hardship distributions from Roth 401(k) accounts. The total amount of all deferrals — traditional and Roth — may be available. As long as the participant doesn’t exceed this cumulative deferral amount, the hardship may be made from either or both accounts, including earnings, if desired.

This brief summary presents just a few highlights of the Roth 401(k) regulations. Due to the tax implications, make sure your participants are knowledgeable about Roth 401(k)s before choosing to defer this way. •