Effective on Jan. 1, 2008, IRC §408A(e) permitted the rollover of eligible distributions from 401(a), 401(k), 403(b) and governmental 457(b) plans directly to a Roth IRA. These are referred to by the IRS as QRCs, and by some in the industry “direct conversions.” Therefore, after that date there is no longer a need to follow a two-step process—first to roll over the distribution to a conduit IRA, and then convert the traditional IRA to the Roth IRA. These rollovers (often referred to as “conversions”) were available through 2009 for participants who have adjusted gross income of $100,000 or less.
Beginning Jan. 1, 2010, the income limitation was eliminated. Signed into law on Sept. 27, 2010, is legislation which also permits the rollover of pre-tax 403(b) and 401(k) accounts to Roth options within the plan. Rollovers of pre-tax governmental 457(b) assets to the Roth 457(b) option offered in the plan will also be permitted after the Jan. 1, 2011 effective date of the Roth 457(b) option.
Plans are required to permit the recipient of an eligible rollover distribution to elect a direct rollover option to avoid the otherwise applicable 20 percent mandatory federal income tax withholding requirement. Where the participant does not elect direct rollover treatment, the distribution can be indirectly rolled over to the Roth IRA within 60 days.
While income taxes do apply to the rollover or conversion, there is no IRS premature distribution penalty taxes applied to the rollover. Finally, if the rollover was accomplished in 2010, the participant could have chosen to include the taxable portion of the conversion as 2010 income– or split the income equally in 2011 and 2012. Once the rollover (conversion) has been deposited into the Roth IRA, a five-year holding period applies before distributions from the amount of the rollover that was includible in income can be taken without federal taxes or penalty taxes (if applicable). If a distribution occurs prior to the 5-year period from the conversion source then the IRS will charge a “recapture” tax for the premature distribution tax that would have applied at the point of conversion.
Editor’s Note: This is an occasional feature in the NTSA Advisor. It is drawn from The Source, a book that covers technical, compliance, administrative and marketing aspects of the 403(b) and 457(b) markets. More information about The Source is available here.
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