Understanding the Roth Contribution Feature : 401(k) Plans and ERISA 403(b) Plans

Transcription

1 A Roth 401(k) and Roth ERISA 403(b) Plan Guide for Plan Sponsors Understanding the Roth Contribution Feature : 401(k) Plans and ERISA 403(b) Plans FOR PLAN SPONSOR USE ONLY.

2 Contents 1 Overview 2 The Roth contribution feature 3 Frequently asked questions 4 Distributions and rollovers 5 Consider administration and testing 6 Does a Roth 401(k) or Roth ERISA 403(b) feature measure up for your organization? 7 Is your plan Roth ready? 8 Review your options 9 Get your employees onboard

3 Overview You may have heard about the Roth contribution feature that is available for 401(k) and ERISA 403(b) Plans. Perhaps you ve read the many articles published on the subject. However, you may still have questions, such as: What impact would this optional feature have on your organization s retirement plan? What should every plan sponsor know when considering its attributes? For whom and in what situations might a Roth 401(k) feature be appropriate? The following guide may help answer some of the commonly asked questions about this feature for 401(k) and ERISA 403(b) plans. 1

4 The Roth contribution feature The Roth contribution feature allows participants the option of designating all or a portion of their contributions as an after-tax Roth contribution. Any 401(k) plan or ERISA 403(b) plan, new or existing, has the option of adding a designated Roth contribution feature. The Roth contribution feature provides your employees with the flexibility to pay their tax liability during their working years in order to receive tax-free* benefits at retirement. The tax-free feature means that the Roth account earnings will not be subject to federal income taxes on qualified distributions. (State income taxes may vary.) Key characteristics of a Roth 401(k) or Roth ERISA 403(b) Plan contribution feature: The ability to make Roth contributions is an optional plan feature (it is not required). Roth contributions are made on an after-tax basis subject to all applicable payroll withholding taxes. Qualified distributions are tax free if they meet certain requirements.* Employees at any income level may make Roth contributions. Contributions are available for participant loans, if loans are allowed under the plan. Roth 401(k) and Roth ERISA 403(b) contributions may be matched** on a before-tax basis. Terminated employees have the option of rolling over their Roth subaccount to a Roth IRA or another plan with a Roth feature. 401(k) and ERISA 403(b) contributions can be: A. Pretax B. After-tax C. Both Accumulating enough assets for retirement is an ongoing concern for everyone. How much to contribute and where to invest are key factors in adequately preparing for retirement. If a Roth contribution feature is added to a 401(k) plan or ERISA 403(b) plan, your plan participants also have the added decision of determining how, and when, they want their contributions taxed. There is no one right answer, so it s important that participants have as much information and education as possible. Roth 401(k): Myth vs. Reality Myth Roth 401(k) or Roth ERISA 403(b) requires a separate product Roth 401(k) or Roth ERISA 403(b) can only be structured as a standalone retirement program. Roth 401(k) or Roth ERISA 403(b) replaces traditional after-tax contributions. Reality Roth contributions are an optional feature that may be incorporated in an existing plan design. No distinct product is required. Separate accounting is required. Roth 401(k) or Roth ERISA 403(b) is a feature added to a traditional 401(k) or ERISA 403(b) plan. It is nothing more than an additional contribution source with unique distribution requirements, integrated into an existing retirement program. Not necessarily. A plan sponsor may still offer traditional after-tax contributions. Participants can split their elective contributions between traditional and Roth, up to the annual maximum on a combined basis. * Distribution of earnings are eligible for federal tax-free treatment if made after five years following the first Roth 401(k) contribution, and due to death, disability, or attainment of age 59½. ** Before-tax employer contributions are subject to ordinary income tax upon withdrawal and may be subject to an additional 10 percent federal tax penalty if taken prior to age 59½. 2

5 Frequently asked questions How are contributions made to a Roth 401(k) or Roth ERISA 403(b) Plan? Participants can direct their salary deferral contributions into a Roth bucket, or a traditional pre-tax contribution* bucket, or a combination of both. These contributions can equal a total of $18,000 in 2017, which is indexed to rise with inflation. Can catch-up contributions be designated as Roth contributions? Yes. Participants are eligible to designate all or a portion of their age 50+ catch-up contributions ($6,000 in 2017) as a Roth deferral contribution. How will matching contributions be treated? Regardless of the employee contribution type, your matching contributions will always be made on a before-tax basis, and are taxable upon withdrawal. How are Roth 401(k) and Roth ERISA 403(b) contributions different from Roth IRA contributions? Will one affect the other? Roth 401(k) and Roth ERISA 403(b) contributions are separate and distinct from Roth IRA contributions. Contributions made to employer-sponsored retirement plan accounts will not affect contributions to the Roth IRA, and vice-versa. Unlike Roth IRAs, a Roth 401(k) or Roth ERISA 403(b) contribution feature allows participants of any income level to designate Roth contributions to be credited to their retirement plan account. No separate income limitation rules apply. Generally, allowable contributions to Roth IRAs in 2017 are reduced for those with modified adjusted gross incomes ( MAGI ) of $118,000 - $133,000 for single individuals or $186,000 - $196,000 for married couples filing jointly. No contributions are allowed if, in 2017, MAGI exceeds $133,000 (single) or $196,000 (married filing jointly). Can I have traditional after-tax contributions available in a 401(k) or ERISA 403(b) plan along with the new Roth contribution feature? Yes. Voluntary traditional after-tax contributions are still allowed. Plan sponsors should consider whether it makes sense to include both a traditional after-tax and a Roth contribution feature, however. What are the potential disadvantages to offering a Roth 401(k) or Roth ERISA 403(b) feature in my retirement plan? While there are benefits to offering a Roth contribution feature, there will be some challenges to consider prior to implementation. Here is a list of some of the more important considerations: Operations: Plan sponsors should know that the following items, if applicable, will require changes prior to establishing a Roth contribution feature: Internal systems to separately account for Roth contributions Various plan-specific documents, including: plan document amendment summary plan description modifications Enrollment and distribution material(s) update Education: Educating plan participants on the operation of a Roth 401(k) or Roth ERISA 403(b) feature will be necessary for them to decide if this new optional feature may be beneficial to them. *For purposes of this brochure, traditional contributions are defined as elective tax-deferred contributions. 3

6 Distributions and rollovers Encouraging participants to contribute to their retirement plan is only part of the process. Educating them about their distribution and rollover options is next. Below are some of the commonly asked questions about distributions and rollover rules applicable to 401(k) and ERISA 403(b) plans with a Roth contribution feature. What are the rules around Roth 401(k) distributions? For purposes of distribution eligibility, Roth 401(k) and Roth ERISA 403(b) distribution amounts are treated the same as pretax 401(k) and ERISA 403(b) distribution amounts. Distributions may be made upon: Severance of service Death Disability Attainment of age 591/2 Financial hardship (designated Roth contributions only not earnings) For tax-free treatment, the Roth 401(k) distribution must be a qualified distribution, that is made after the five-year non-exclusion period, and due to death, disability, or attainment of age 591/2. What is the five-year non-exclusion period? The five-year non-exclusion period begins with the earlier of: For example: If a participant makes their first Roth 401(k) or ERISA 403(b) contribution on February 1, 2013, then their withdrawals are not tax free until January 1, 2018 (provided the additional distribution requirements are met). Are Roth 401(k) contributions available for participant loans? Yes. Roth contributions are available for participant loans, if allowed by the plan. Specific plan provisions should be reviewed to determine appropriateness. How do Roth 401(k) or Roth ERISA 403(b) withdrawals and Roth IRA withdrawals differ? The distribution rules that apply to Roth 401(k) or Roth ERISA 403(b) plans and Roth IRAs are not identical. Roth 401(k) and Roth ERISA 403(b) distributions will always be represented by principal (contributions) and earnings. Roth IRA distributions are processed according to ordering rules that allow for return of contributions first. This feature allows for federal tax-free distribution for any reason and is not available to Roth 401(k) or Roth ERISA 403(b) distributions. What about rollovers? Terminated employees have the option of rolling over their Roth 401(k) or Roth ERISA 403(b) balance to either a Roth IRA or another retirement program that includes a Roth contribution feature that accepts Roth rollovers. The first tax year for which a designated Roth account is established under the plan by the participant; or If a Roth rollover contribution is made, the first taxable year the individual first made a designated Roth contribution to the other applicable retirement plan. 4

7 Consider administration and testing As a plan sponsor, you may be wondering how adding a Roth 401(k) or Roth ERISA 403(b) plan feature will affect your testing and everyday plan administration. The following questions and answers offer a high-level breakdown of what you can expect. What effect will the Roth 401(k) or Roth ERISA 403(b) have on testing? Actual Deferral Percentage ADP Test Roth 401(k) or Roth ERISA 403(b) contributions are aggregated with, and treated as, elective deferrals for purposes of the ADP test. If a failed ADP test is corrected by distributions, a plan may provide that contributions be returned to the highly compensated employees* from either before-tax or Roth contributions. Actual Contribution Percentage ACP Test After-tax, Roth 401(k) or Roth ERISA 403(b) contributions are not included with after-tax contributions in the ACP test. Does adding this feature require a plan amendment? Yes. Plan sponsors have until the end of the plan year in which the plan adopts the Roth 401(k) or Roth ERISA 403(b) feature to amend the plan. Will there be a cost? Plan sponsors looking to add a Roth 401(k) or Roth ERISA 403(b) feature to their retirement program should contact their financial professional, third-party administrator (if applicable), or current plan provider to learn about cost considerations. What kind of administration changes should I keep in mind? Roth 401(k) or Roth ERISA 403(b) contributions require a separate account source, where service providers will be required to track all of the following items: Roth 401(k) or Roth ERISA 403(b) contributions Roth 401(k) or Roth ERISA 403(b) contribution gains and losses Roth 401(k) or Roth ERISA 403(b) distributions * Highly compensated employees (HCEs) are generally defined as employees who are 5% owners in a current or preceding plan year, or, for 2017, generally any employees who have earned $120,000 or more in the preceding year (2016). 5

8 Does a Roth 401(k) or ERISA Roth 403(b) feature measure up for your organization? Depending on plan goals and employee needs, the decision whether to introduce a Roth 401(k) or Roth ERISA 403(b) plan feature may vary by plan. To help determine appropriateness for your plan, consider the following questions. If the answer to most of these questions is yes, a Roth contribution feature may be a good fit for your plan. Roth 401(k) or Roth 403(b) Plan key considerations Tax considerations Do you or your employees believe your/their personal tax rate will rise in the future? Do you believe income tax rates will rise in the future? Is your employee base predominantly lower-paid and younger in age? Estate planning Do you have employees who may wish to preserve assets for their heirs by rolling over their Roth 401(k) or Roth ERISA 403(b) assets to a Roth IRA, thereby avoiding required minimum distributions? Contribution impact Do you have employees looking to pay their tax liability during their working years? Do you believe some of your plan participants are aggressive investors seeking to take advantage of tax-free earnings at retirement? Flexibility Might some employees benefit from the ability to invest on both a pre-tax and/or after-tax basis? Do you have higher paid employees* whose income previously excluded them from contributing to a Roth IRA and who may want the added flexibility of a Roth 401(k) or Roth ERISA 403(b)? There may be additional considerations applicable to your plan beyond those listed. MassMutual does not provide tax, investment, accounting or legal advice. You should consult your own investment, tax, and/or accounting professional before making determinations on your plan. * Generally, allowable contributions to Roth IRAs in 2017 are reduced for those with modified adjusted gross incomes ( MAGI ) of $118,000 $133,000 for single individuals or $186,000 $196,000 for married couples filing jointly. No contributions are allowed if, in 2017, MAGI exceeds $133,000 (single) or $196,000 (married filing jointly). 6

9 Is your plan Roth ready? Knowing the administrative impact of establishing a Roth 401(k) or ERISA Roth 403(b) feature is crucial in making the decision to move forward. Below is a quick checklist to help you understand what needs to be considered and completed prior to adopting this feature. Please note, you will need to amend your plan for items marked Plan Document Change. Roth Readiness chart Operational change Plan document change Educational opportunity Item to consider Potential impact Completed Decide when you wish to adopt the Roth 401(k) or Roth ERISA 403(b) feature for your plan. If applicable, verify that your outside payroll company is ready to accommodate Roth 401(k) or Roth ERISA 403(b) contributions. Ensure that your internal payroll system is ready to segregate traditional and Roth contributions. Decide if you wish to establish guidelines for changing from traditional contributions to Roth contributions, and vice versa. Determine if the plan will allow participants to choose between pretax and Roth contributions as the source from which excess contributions will be returned. Work with your plan provider and financial professional to determine what enrollment support and materials will be used. For ongoing educational sessions, contact your plan provider and financial professional for timely Roth updates and educational presentations. Please Note: If your plan is subject to the U.S. Department of Labor s participant-level fee disclosure 404(a)(5) regulation, certain changes to the operation of your plan, your plan s list of investment options, or the administrative and individual fees associated with plan participation may be triggering events under the regulation requiring notice of the changes to your participants. Under the regulations, change notifications must generally be distributed at least 30 but not more than 90 days before the effective date of the change, except when such notice is not possible (such as the immediate elimination of an investment option that has been determined to no longer be a suitable investment alternative), in which case, the plan must generally provide notice of the change as soon as practicable. 7

10 Review your options How do these products/features compare? Employer Sponsored Traditional 401(k) or ERISA 403(b) 1 Roth 401(k) or Roth ERISA 403(b) Yes Yes No Roth IRA Income Eligibility No income limits No income limits Generally, allowable contributions to Roth IRAs in 2017 are reduced for those with modified adjusted gross incomes ( MAGI ) of $118,000 $133,000 for single individuals or $186,000 $196,000 for married couples filing jointly. No contributions are allowed if, in 2017, MAGI exceeds $133,000 (single) or $196,000 (married filing jointly). Contributions Pretax After-tax After-tax Contribution Limits $18,000 in 2017 for traditional and Roth contributions combined ($24,000 if age 50+) $18,000 in 2017 for traditional and Roth contributions combined ($24,000 if age 50+) $5,500 in 2017 ($6,500 if age 50+) Investment Earnings Taxable when distributed Federal tax free, if qualified distribution 2 Federal tax free, if qualified distribution 2 Withdrawals Taxable Federal tax free, if qualified distribution 2 Distribution Restrictions Qualified Distribution Requirements Minimum Distribution Requirements Rollover Considerations Death, disability, termination of employment, plan termination, attainment of age 59½, and financial hardship (deferrals only) No qualified distribution requirements Death, disability, termination of employment, plan termination, attainment of age 59½, and financial hardship (designated Roth contributions only) Distributions must occur at least 5 years following the first Roth 401(k) contribution, and due to death, disability, or attainment of age 59½ Federal tax free, if qualified distribution 2 Not applicable Distributions must occur at least 5 years following the first Roth IRA contribution, and due to death, disability, first-time home purchase or attainment of age 59½ Age 70½ Age 70½ No minimum distribution requirements Traditional 401(k) to another traditional 401(k), 403(b), or 457(b) plan, or a traditional IRA, or if allowed under the terms of the Plan, to a Roth IRA Roth 401(k) to a Roth IRA or to another retirement program with a Roth feature 3 Vesting 100% immediate 100% immediate Not applicable Roth IRA to Roth IRA (No Roth IRA to Roth 401(k) allowed) 1 Traditional 401(k) contributions are defined as elective tax-deferred contributions. 2 For federal tax-free treatment, the distribution must be a qualified distribution, and due to death, disability, or attainment of age 59½. 3 Must be an eligible rollover distribution made due to a distributable event (e.g., termination of employment) under the terms of the retirement program. 8

11 Get your employees onboard Sample employee notice [Date] [Employee Name] 123 Park Lane Anywhere, State IMPORTANT NOTICE REGARDING THE ABC COMMUNICATIONS RETIREMENT PLAN Dear [Employee Name], We re pleased to announce some important changes to the ABC Communications retirement plan that may be of interest to you. It s time to notify employees. Sending a brief communication on your latest plan enhancement will be a welcome heads-up to employees. All eligible employees now may consider making 401(k) [ERISA 403(b)] contributions on a Roth after-tax basis. This new feature allows you to designate all or a portion of your 401(k) or ERISA 403(b) contributions as designated Roth contributions. These after-tax contributions are similar to Roth IRA amounts. However, please note: Unlike Roth IRAs, there are no income limitations. All participants may make Roth 401(k) [ERISA 403(b)] contributions. Unlike Roth IRAs, Roth 401(k) [ERISA Roth 403(b)] contributions] are available for participant loans. Qualified distributions of earnings/income are federal tax-free.* Roth 401(k) [ERISA 403(b)] contributions will be considered under the plan s matching formula (if the plan has matching contributions). Roth 401(k) [ERISA 403(b)] contributions are subject to required minimum distributions. On [Date], a specialist from MassMutual will be on-site to address any questions you may have, and provide additional information to help you determine whether this feature is appropriate for you. Sincerely, [Plan Administrator] * Distribution of earnings are eligible for federal tax-free treatment if made after five years following the first Roth 401(k) contribution, and due to death, disability or attainment of age 59½. Note: You should not include this in your notice if the plan does not allow for loans. Note: You should not include this in your notice if the plan does not include a matching contribution. For more information on whether the Roth 401(k) or Roth ERISA 403(b) feature is right for your retirement program, call your financial professional or your team at MassMutual at , option 4. 9

12 The information contained in this guide is not intended or written as specific legal or tax advice and may not be relied on for purposes of avoiding any federal tax penalties. Neither MassMutual nor any of its employees or representatives are authorized to give legal or tax advice. You must rely on the advice of your own independent tax counsel. Many tax-planning strategies emphasize the deferral of current income taxes, on the basis that your federal income tax rate may be lower at retirement. Please keep in mind that federal income tax rates are unpredictable and may be higher when you take a distribution than at the time of deferral. Other factors, including state tax rates and your income, may also affect your overall tax rate upon distribution. Please consult with your tax advisor for individual tax-planning strategy and advice. MassMutual does not predict or in any way guarantee favorable tax results Massachusetts Mutual Life Insurance Company, Springfield, MA All rights reserved. MassMutual Financial Group is a marketing name for Massachusetts Mutual Life Insurance Company (MassMutual) and its affiliated companies and sales representatives. Exp: 12/01/2018 RS C: