Designated Roth Accounts in 401(k) or 403(b) Plans
Beginning in 2006, an employer's 401(k) or 403(b) plan may permit an employee to designate some or all of his or her elective contributions under the plan as designated Roth contributions. This means a participant in a cash or deferred arrangement under a 401(k) plan or under a 403(b) salary reduction agreement that includes qualified Roth contributions may elect to make designated Roth contributions to the plan in lieu of elective deferrals.
Please be aware that this is not a new type of plan. Designated Roth contributions are a new type of contribution that can be accepted by new or existing 401(k) and 403(b) plans. This feature is permitted under a Code section added by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).
For employees to make designated Roth contributions to a 401(k) or 403(b) plan, an employer's plan must contain language that allows for these Roth contributions. IRS Notice 2006-44 provides a sample plan amendment for sponsors, practitioners, and employers (plan sponsors) who want to provide for designated Roth contributions in their section 401(k) plans.
Roth 401(k) or Roth 403(b) Basics and Contribution Limits
The main difference between a traditional 401(k) or 403(b) plan and the Roth plans has to do with taxation. Employee contributions to traditional plans are made with pre-tax earnings. However, the contributions and any earnings are taxable when the employee later makes a "qualified distribution" from their 401(k) or 403(b) retirement account. Conversely, employee designated contributions to the Roth 401(k) or Roth 403(b) plans are made with after-tax dollars, and any "qualified distributions" of the contributions and earnings would be tax-free.
The IRS says that the employee's maximum contribution limits apply to the employee's total contributions to both plans. For instance, for tax year 2006 the total combined employee contributions to a 401(k) [traditional or Roth] cannot exceed $15,000 for participants under age 50 and $20,000 for participants 50 or older. You must keep track of the combined contributions for employees who contribute to both a Roth and a traditional 401(k) or 403(b) account, and stop the employee contributions when the employee reaches the combined limit.
Important Details
Some important information to know:
- Designated Roth contributions are elective contributions that, unlike pre-tax elective contributions, are currently includible in gross income. If a 401(k) plan is going to provide for designated Roth contributions, it must also offer pre-tax elective contributions.
- A designated Roth account is a separate account under a 401(k) or 403(b) plan to which designated Roth contributions are made and for which separate accounting of contributions, gains, and losses is maintained.
- The employee contributions to a Roth 401(k) will be reported on Form W-2 in box 12 with a code of AA.
- The employee contributions to a Roth 403(b) will be reported on Form W-2 in box 12 with a code of BB.
- Form W-3 will be affected because the amounts reported on the W-2 forms in box 12 with code AA or BB will be included in the total amount reported in box 12 of Form W-3.
- Employers can make matching contributions on designated Roth contributions; however, only an employee's designated Roth contributions can be allocated to designated Roth accounts. The employer's matching contributions made on account of designated Roth contributions must be allocated to a pre-tax account, just as matching contributions on traditional, pre-tax elective contributions are.
Read more about designated Roth accounts on the IRS Web site:
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