In Plan Roth Rollover - Does Your Plan Permit it?

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In the “Blue Book” for the recently enacted American Taxpayer Relief Act of 2012 , the Joint Committee on Taxation provided a detailed explanation of the Internal Revenue Code provision regarding how to accomplish a qualified “in-plan Roth rollover” starting January 1, 2013.   This Blue Book explanation is helpful since no formal committee report or other explanation has been provided yet.

Taxpayers generally may transfer or convert amounts in a traditional IRA to a Roth IRA if such amounts are eligible for rollover by either doing a 60-day rollover, a trustee-to-trustee transfer, or an account re-designation.  The amount so transferred or converted is includible in income as if a withdrawal had been made, except that the 10% early withdrawal tax won’t apply.

The Blue Book notes that amounts under a qualified plan are distributable only as permitted under the terms of the plan and law.  One law that applies to plans generally is a requirement that amounts contributed to a 401(k) or profit sharing plan may not be distributed in-service for at least two years.   So even if no other statutory distribution restriction applies to an amount, the plan must generally contain language that permits in-service distributions after a fixed number of years, and such fixed number of years must be no less than two.

But if a qualified plan has a qualified Roth contribution program, any amount eligible under the plan for distribution and rollover to another eligible plan may be rolled over into a designated Roth account in the plan for the individual.   If this is done, the amount rolled-over is includible in gross income (except to the extent it represents after-tax contributions), but the 10% early distribution tax won’t apply.

The 2012 Taxpayer Relief Act provides that an applicable retirement plan that includes a qualified Roth contribution program may allow an individual to elect to have the plan transfer amounts not otherwise distributable under the plan to a designated Roth account in the plan maintained for the individual's benefit.  Under the 2012 Taxpayer Relief Act, the plan will not be treated as violating the restrictions on distributions applicable to such plan solely because of the transfer.

The Blue Book explains that the new law doesn't change the basic character of the amounts being rolled-over.  So if otherwise non-distributable amounts are rolled-over into the Roth account, such amount remain non-distributable.   For example, an amount in a 401(k) or profit-sharing plan which is not distributable because the required number of years has not passed remains non-distributable for the balance of the required number of years.

Making a rollover contribution to a Roth account is not without cost.  In exchange for getting tax-free distributions out of the Roth account down the road, you are required to recognize and pay tax now on the amount rolled over.  In evaluating whether you should make a Roth rollover, you need to consider how much tax you would pay now versus how much tax you expect to save later, and also consider how long you have before retirement and how you expect your plan investments to perform.   This can be a bit of a guessing game.   The income and capital gains rates have changed recently and it is not unlikely they will change again in the future.  And while the stock market has been ticking upwards, will that continue?

Please call or contact me at 937-223-1130 or Jsenney@pselaw.com if you would like to discuss the new in-plan Roth rollover provision further.

AND ONE MORE THING.   For some time, the IRS and the courts have held that the annual gift exclusion is unavailable for certain transfers involving minority interests in closely held business entities.  The IRS has taken the position that gifts of minority interests in closely held entities do not qualify as gifts of present interests, and are therefore ineligible for the annual exclusion, where the distribution of profits in those entities is discretionary and such minority interest are subject to transfer restrictions.  A recent Tax Court case, however, has drawn a distinction where entity income was somewhat predictable and where some income was paid to owners annually.  If you would like to know more about the annual gift exclusion, business valuation discounts, or succession planning please call or contact me at 937-223-1130 or Jsenney@pselaw.com