The Internal Revenue Service has released a draft of regulations that could help sponsors and administrators manage the new Roth retirement accounts.
The draft regulations, published today in the Federal Register, deal with topics such as the taxation of Roth 401(k) plan and Roth 403(b) plan accounts.
One section of the preamble to the draft regulations discusses rollovers of Roth retirement plan account assets into Roth individual retirement accounts.
The Internal Revenue Code sections that govern Roth IRAs and Roth 401(k) accounts let taxpayers fund the accounts with income that already has been taxed. In exchange, the government promises not to impose additional taxes on qualified distributions.
A Roth IRA holder who keeps the money in the account at least 5 years can use distributions to pay some expenses, such as the holder’s first purchase of a home, without paying penalties or taxes on the account earnings.
Roth 401(k) account holders also can take tax-free withdrawals after 5 years if they reach age 59.5, die or become disabled.
What happens to the 5-year rule if a Roth 401(k) account holder rolls account distributions into a Roth IRA?
Some commentators told the IRS that a taxpayer who rolls Roth 401(k) account assets into a Roth IRA should be able to use the years when the cash was in the Roth 401(k) account to meet the 5-year participation requirement for taking Roth IRA distributions.
“The IRS and the Treasury Department do not believe that the code permits this interaction between the 2 5-year rules,” Cathy Vohs and R. Lisa Mojiri-Azad, IRS officials, write in the preamble to the draft regulations.
If a worker established a Roth IRA during the years when he was contributing to the Roth 401(k) account and later rolls the Roth 401k) assets into the existing Roth IRA, then the 5-year participation period started when the worker started the Roth IRA, Vohs and Mojiri-Azad write.
If a worker rolls Roth 401(k) assets into a new Roth IRA, then the 5-year Roth IRA participation period starts when the worker starts the Roth IRA, Vohs and Mojiri-Azad write.
In theory, the interpretation means that workers who start Roth IRAs as soon as they begin contributing to Roth 401(k) accounts may be able to roll assets into the existing Roth IRAs and withdraw the rolled-over assets to buy homes or cover college costs in as little as 5 years.
Workers who have money in Roth 401(k) accounts for 5 years and then roll assets into new Roth IRAs could have to wait a total of 10 years from the time they begin making Roth 401(k) contributions to use Roth assets to pay college bills or buy homes.
A copy of the proposed regulation is on the Web at Document Link