Senate Finance Committee Report's Discussion of Proposed Roth 401(k)

From Senate Report 106-411
RETIREMENT SECURITY AND SAVINGS ACT OF 2000

G. OPTION TO TREAT ELECTIVE DEFERRALS AS ROTH AFTER-TAX CONTRIBUTIONS (SEC. 207 OF THE BILL AND SEC. 402A OF THE CODE)

PRESENT LAW

A qualified cash or deferred arrangement ('section 401(k) plan') or a tax-sheltered annuity ('section 403(b) annuity') may permit a participant to elect to have the employer make payments as contributions to the plan or to the participant directly in cash. Contributions made to the plan at the election of a participant are elective deferrals. Elective deferrals must be nonforfeitable and are subject to an annual dollar limitation (sec. 402(g)) and distribution restrictions. In addition, elective deferrals under a section 401(k) plan are subject to special nondiscrimination rules. Elective deferrals (and earnings attributable thereto) are not includible in a participant's gross income until distributed from the plan. 

Individuals with adjusted gross income below certain levels generally may make nondeductible contributions to a Roth IRA and may convert a deductible or nondeductible IRA into a Roth IRA. Amounts held in a Roth IRA that are withdrawn as a qualified distribution are neither includible in income nor subject to the additional 10-percent tax on early withdrawals. A qualified distribution is a distribution that (1) is made after the 5-taxable year period beginning with the first taxable year for which the individual made a contribution to a Roth IRA, and (2) is made after attainment of age 59 1/2 , is made on account of death or disability, or is a qualified special purpose distribution (i.e., for first-time homebuyer expenses of up to $10,000). A distribution from a Roth IRA that is not a qualified distribution is includible in income to the extent attributable to earnings, and is subject to the 10-percent tax on early withdrawals (unless an exception applies). 17 
[Footnote] 

[Footnote 17: Early distributions of converted amounts may also accelerate income inclusion of converted amounts that are taxable under the 4-year rule applicable to 1998 conversions.]

 REASONS FOR CHANGE

The recently-enacted Roth IRA provisions have provided individuals with another form of tax-favored retirement savings. For a variety of reasons, some individuals may prefer to save through a Roth IRA rather than a traditional deductible IRA. The Committee believes that similar savings choices should be available to participants in section 401(k) plans and tax-sheltered annuities.

 EXPLANATION OF PROVISION

A section 401(k) plan or a section 403(b) annuity is permitted to include a `qualified Roth contribution program' that permits a participant to elect to have all or a portion of the participant's elective deferrals under the plan treated as designated Roth contributions. Designated Roth contributions are elective deferrals that the participant designates (at such time and in such manner as the Secretary may prescribe) 18 [Footnote] as not excludable from the participant's gross income. 

[Footnote 18: It is intended that the Secretary will generally not permit retroactive designations of elective deferrals as Roth contributions.] 

The annual dollar limitation on a participant's designated Roth contributions is the section 402(g) annual limitation on elective deferrals, reduced by the participant's elective deferrals that the participant does not designate as designated Roth contributions. Designated Roth contributions are treated as any other elective deferral for purposes of nonforfeitability requirements and distribution restrictions. 19 [Footnote] Under a section 401(k) plan, designated Roth contributions also are treated as any other elective deferral for purposes of the special nondiscrimination requirements. 20 [Footnote] 

[Footnote 19: Similarly, Roth contributions to a section 403(b) annuity are treated the same as other salary reduction contributions to the annuity (except that Roth contributions are includible in income).] 

[Footnote 20: It is intended that the Secretary will provide ordering rules regarding the return of excess contributions under the special nondiscrimination rules (pursuant to sec. 401(k)(8)) in the event a participant has made both regular elective deferrals and Roth contributions. It is intended that such rules will generally permit a plan to allow participants to designate which contributions are returned first or to permit the plan to specify which contributions are returned first.] 

The plan would be required to establish a separate account, and maintain separate recordkeeping, for a participant's designated Roth contributions (and earnings allocable thereto). A qualified distribution from a participant's designated Roth contributions account would not be includible in the participant's gross income. A qualified distribution is a distribution that is made after the end of a specified nonexclusion period and that is (1) made on or after the date on which the participant attains age 59 1/2 , (2) made to a beneficiary (or to the estate of the participant) on or after the death of the participant, or (3) attributable to the participant's being disabled. 21 [Footnote] The nonexclusion period is the 5-year-taxable period beginning with the earlier of (1) the first taxable year for which the participant made a designated Roth contribution to any designated Roth contribution account established for the participant under the plan, or (2) if the participant has made a rollover contribution to the designated Roth contribution account that is the source of the distribution from a designated Roth contribution account established for the participant under another plan, the first taxable year for which the participant made a designated Roth contribution to the previously established account. 

[Footnote 21: A qualified special purpose distribution, as defined under the rules relating to Roth IRAs, does not qualify as a tax-free distribution from a designated Roth contributions account.] 

A distribution from a designated Roth contributions account that is a corrective distribution of an elective deferral (and income allocable thereto) that exceeds the section 402(g) annual limit on elective deferrals or a distribution of excess contributions (and income allocable thereto) is not is a qualified distribution. 22 [Footnote] 

[Footnote 22: Such distributions are not includible in income to the extent they are a return of Roth contributions, because the initial contribution is includible in income.] 

A participant is permitted to roll over a distribution from a designated Roth contributions account only to another designated Roth contributions account or a Roth IRA of the participant. 

The Secretary of the Treasury is directed to require the plan administrator of each section 401(k) plan or section 403(b) annuity that permits participants to make designated Roth contributions to make such returns and reports regarding designated Roth contributions to the Secretary, plan participants and beneficiaries, and other persons that the Secretary may designate. 

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