Roth Elective Deferrals. A Reference Manual For Employers

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1 Roth Elective Deferrals A Reference Manual For Employers

2 You may have read about Roth elective deferrals in various trade journals or retirement publications since their inception in January More likely than not, you have some questions surrounding this new savings opportunity. What impact would this new option have on our existing retirement plan? What administrative steps are necessary to offer this new plan feature? What type of investor might benefit from Roth elective deferrals? GuideStone s desire is to partner with you as you consider this retirement plan feature. We trust that the following reference manual will help answer these and many other commonly asked questions surrounding Roth contributions.

3 Table of Contents Background... 4 Contributions and loans... 5 Distributions and rollovers... 7 Administrative considerations... 8 Decision to implement While care has been taken in preparation of this information, no warranty, express or implied, is given to any person or entity with respect to the accuracy of the information. The general information in this publication is not intended to be nor should it be treated as tax, legal or accounting advice. Additional issues could exist that would affect the tax treatment of a specific transaction and, therefore, taxpayers should seek advice from an independent tax advisor based on their particular circumstances before acting on any information presented. This information is not intended to be nor can it be used by any taxpayer for the purpose of avoiding tax penalties.

4 Background In 2001, The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) introduced a provision which would allow 403(b) and 401(k) retirement plans to provide participants the option of designating all or a portion of their contributions as an after-tax or Roth contribution. This provision became reality in 2006 for plan sponsors, and now any 403(b) or 401(k) retirement plan has the option of adding the Roth feature for its participants. Remember, the Roth 403(b) or 401(k) also known as Roth elective deferrals is just that, a plan feature. It is simply an additional contribution option added to an existing retirement plan. Key features Roth elective deferrals are an optional plan feature that may be incorporated in an existing plan design. No distinct product is required, however separate accounting is required. Contributions are made on an after-tax basis. However, offering Roth elective deferrals does not necessarily replace other after-tax contributions. A plan sponsor may still offer both after-tax and Roth contributions simultaneously in their plan. Contributions are available for participant loans, if loans are allowed in the plan. You cannot convert existing or prior pre-tax or after-tax contributions into Roth after-tax contributions Roth contribution designations are for future contributions only. Employees with any level of income may make Roth elective deferrals into the plan. Roth contributions may be matched by the employer on a pre-tax basis. (It is important to note that pre-tax employer contributions are subject to ordinary income tax upon withdrawal and may be subject to additional federal income tax penalties if taken prior to age ). Qualified distributions are tax-free if they meet certain requirements.* *Distribution of earnings eligible for tax-free treatment if made after the five year non-exclusion period following the first Roth elective deferral, and due to death, disability or attainment of age

5 Contributions and Loans Retirement planning and wealth accumulation are concerns for any level of investor. Questions like, how much do I need to contribute to meet my individual goals? and what funds should I choose? are familiar to many plan administrators. Your employees are not immune to these concerns. Adding plan features like Roth elective deferrals to an already sometimes puzzling retirement picture can often overwhelm employees into taking little to no action in regard to their overall retirement plan well-being. If a Roth feature is added to your retirement plan, participants in the plan will also have the additional decisions of determining how and when they want their contributions taxed. Our hope is that the following Q&A portion of this manual can help alleviate some of your employees concerns and empower you to make smart decisions surrounding your plan with GuideStone. Can a retirement plan offer both pre-tax contributions and the Roth contribution feature? Yes. In fact, if a plan sponsor elects to offer Roth contributions then they must also continue to offer pre-tax contributions simultaneously in their plan. How do pre-tax and Roth elective deferrals impact one another? Participants can direct their contributions into the plan by using pre-tax contributions, Roth elective deferrals or a combination of the two. Remember, the sum of these contributions cannot exceed an individual s limit on salary reduction contributions (402(g) limit). Can a plan have after-tax contributions available along with the Roth contribution feature? Yes. After-tax contributions are still allowed. How will an employer s matching contribution be treated? Employer contributions that match Roth elective deferrals are treated no differently than other employer matching contributions. An employee s contribution type (Roth, pre-tax, or after-tax) has no bearing on matching contributions. Can a participant designate their contributions as pre-tax or a Roth elective deferral after the contribution has already been made? No. Contribution designations including Roth elective deferrals cannot be retroactive. Does a new account need to be established under an employee s 403(b) or 401(k) plan to receive designated Roth contributions? Yes. Designated Roth contributions must be kept completely separate from previous and current 403(b) or 401(k) pre-tax elective contributions. A separate account must be established for each participant making designated Roth contributions this service will be provided by GuideStone to all clients at no cost.

6 Contributions and Loans (Continued) Can catch-up contributions be designated as Roth 403(b) or 401(k) contributions? Yes. Participants can designate all or a portion of their age 50+ catch-up contribution as a Roth 403(b) or 401(k) contribution type. Are Roth elective deferrals available for loans? Yes. Roth elective deferrals are available for participant loans if loans are allowed in the plan. How are Roth IRA and Roth 403(b) or 401(k) contributions different and do they affect one another? Roth IRA and Roth elective deferrals are separate and distinct. Contributions made to either type of account do not affect one another in any way. Additionally, Roth elective deferrals allow employees of any inome level to designate Roth contributions to their plan. With the Roth IRA, income limitation rules often apply.

7 Distributions and Rollovers Many times encouraging employees to take advantage of their employer-sponsored retirement plan can be challenging enough without discussions about distribution or rollover options. Educating your employees on these topics as they relate to the Roth feature is an important piece of the puzzle. Our desire is that the following questions and commentary prove insightful when addressing the issue of distribution options or rollover provisions with your employees. When can participants receive a distribution from a designated Roth account? Roth elective deferrals are subject to the same distribution restrictions as pre-tax contributions. That is, they are only eligible for distribution at death, disability, severance from employment, hardship, or at age Depending on the circumstances, the distribution may be considered a qualified distribution or a non-qualified distribution. What is a qualified distribution from a designated Roth account? A qualified distribution is generally a distribution made after the five-year non-exclusion period following the date of the first Roth elective deferral, and is either: Made on or after the date the employee attains age , Made on or after the date of the employee s death, or Attributable to the employee being disabled. A qualified distribution from a designated Roth account is not includible in the employee s gross income. What happens if a participant takes a non-qualified distribution from their designated Roth account? A non-qualified distribution is included in the participant s gross income to the extent attributable to earnings and is excluded from gross income to the extent attributable to Roth contributions. In addition, a penalty may apply to the earnings if a non-qualified distribution occurs prior to the participant attaining age The amount of a distribution allocated to Roth contributions is determined by applying to the distribution the ratio of the contributions to the overall designated Roth account balance. What is the five-year non-exclusion period? The five-taxable-year period that begins with the earlier of: The first tax year in which the employee makes a Roth elective deferral under the plan or, If a Roth rollover contribution is made, the first taxable year the individual first made a designated Roth elective deferral to the other applicable retirement plan. What do I need to know regarding rollovers? It is important to note that Roth 403(b) balances or Roth 401(k) balances can remain in the plan at termination. However, terminated employees may choose the option of rolling over their Roth 403(b) balance or Roth 401(k) balance. A Roth 403(b) account and Roth 401(k) account may be rolled to a Roth IRA, Roth 403(b) account, or Roth 401(k) account.

8 Administrative Considerations As the individual responsible for administering your organization s retirement plan, you may have questions or concerns regarding the impact that Roth elective deferrals would have on your current plan. Testing considerations, plan amendment procedures, systems impact and other everyday plan administration issues are things to consider when contemplating Roth contributions. Following are some need to knows that will assist you when considering this new opportunity. Does adding this feature require a plan amendment? If so, does GuideStone charge a fee for the amendment? Adding the Roth feature does require a plan amendment. If your organization chooses to amend their plan in order to accommodate for the Roth feature, GuideStone will provide the amendment at no cost. How do I go about amending my plan document to accommodate the Roth feature? Simply contact your marketing support specialist to add the Roth feature to your plan. What changes in current administrative policy should I keep in mind when considering the Roth feature? Roth elective deferrals contributions require a separate account source. Plan providers will be required to track the following items in that separate source. Roth 403(b) or 401(k) contributions. Roth 403(b) or 401(k) gains and losses. Roth 403(b) or 401(k) distributions. GuideStone provides these administrative services at no cost to the plan provider. What educational materials are available for employees interested in making Roth contributions to their retirement plan? Beginning January 2007, GuideStone will provide two different Web-based educational materials for your employees. The first uses a Q&A and checklist format to define Roth contributions, discuss suitability and communicate things to consider. The second is a comparative analysis of Roth contributions, pre-tax contributions, and Roth IRAs. These two resources will be found at under the Retirement/Contribution Type drop down menu. Employers may also want to direct their employees to visit the IRS Web site at for more details.

9 Administrative Considerations (continued) What payroll system changes need to be in place for Roth elective deferrals? Roth elective deferrals are required to be separated from other elective deferrals and reported on the Form W-2. Unlike ordinary tax-sheltered deferrals, Roth elective deferrals will not be reduced from the W-2 amount reported in Box 1. If your organization uses an outside payroll provider, discuss with your provider the new contribution option and how this will affect your reporting of the contributions to GuideStone, as well as on Form W-2. If your organization uses the Employer Access Program or receives billing statements, your authorized personnel who remit the contributions will need to make sure they are using the correct codes for the Roth contributions (provided in Employer Access Program). If your organization uses Electronic Data Transfer, your programmer will need to coordinate with GuideStone to make the change for the new contribution code that will be needed to reflect Roth elective deferrals. Please see the Payroll Data Feed manual for more details. Are there any required minimum distribution provisions? Contributions and earnings in the Roth 403(b) or 401(k) are subject to the same RMD requirements as all other retirement plan contributions and earnings. Who can I contact at GuideStone with additional questions about the Roth feature? For additional questions, you can contact your marketing support specialist at GUIDE ( ). Offering this new feature may prove beneficial for many of your employees. One of your responsibilities as plan sponsor is to determine potentially what s best for your employee base as a whole. The information below is aimed at helping you answer two main questions Do Roth elective deferrals make sense for your employees? and Is your organization prepared to integrate this new feature?

10 Decision to Implement Do Roth elective deferrals make sense for my employees? Ask yourself Would my employees benefit from the choice of contributing both pre-tax and/or through Roth elective deferrals? Do we have higher income employees that are subject to Roth IRA income exclusions that might benefit from the additional flexibility Roth elective deferrals offer? Does our employee base consist mainly of younger, lower-paid wage earners and/or employees that believe their personal tax rate will be higher in retirement? Is there a belief in our organization that income tax rates will likely rise in the future? Do we have plan participants that invest aggressively in order to maximize the potential advantage of tax-free earnings in retirement? Is my organization prepared to integrate this new feature? Ask yourself When do we want to adopt the Roth feature for our existing plan? Will this require a board meeting who needs to be involved in this decision? Is our payroll system ready to segregate pre-tax and Roth 403(b) or 401(k) contribution types? Is my organization s Human Resource staff comfortable with explaining the Roth feature? Am I familiar with enrollment and educational support materials provided by GuideStone? Is there a need to establish policies around changing from pre-tax contributions to Roth contributions and vice-versa? For more information, contact us GUIDE ( ) 10

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