Designating employer contributions as Roth contributions

Updated by Richard Phillips, EA, AIFA, CPC, CPFA, QPA, QKA

A 401(k) plan may permit participants to make designated Roth contributions. Under this arrangement the employee elects to designate their elective deferral as a Roth contribution. The designated Roth contribution is not excluded from current income, but distributions that meet certain conditions are considered "qualifying distributions" and not taxed when distributed. This means that investment gains are tax free if the Roth account has satisfied the qualification requirements.

The Roth account must meet two criteria for the distributions to be considered "qualifed distributions" and therefore tax free.

  1. 5-year tax period. The Roth account must be established for at least five years prior to the commencement of distributions. The "Roth start date" is January 1 of the plan year in which the first Roth contributions are made to the plan. The amount of the contribution is irrelevant.
  2. Qualified event or purpose. The qualifed events can be found in IRC §408A(d)(2)(A). They include:
    1. Distributions made after the attainment of age 59.5
    2. Distributions to a beneficiary as a result of death
    3. Distributions on account of disability
Section 604 of the SECURE Act 2.0 amends the definition of a qualifed Roth program to include the ability of participants to designate employer contributions to be Roth contributions.

In order to be able to designate employer contributions as Roth, a participant must be fully vested. The language in the regulations referrs to employer matching contributions as "fully vested" whereas employer contributions (i.e. profit sharing) instead says "nonforfeitable". The IRS has not yet clarified the distinction between the two.

Since the employer contributions are tax deferred, employer contributions that are designated Roth contributions will be currently taxable and therefore subject to current income taxes and reporting requirements.

IRS guidance is needed on tax reporting for employer contributions that are designated Roth contributions.

Until the IRS issues formal guidance on how to report and tax the Roth designated employer contributions, participants may elect an alterntive process that essentially achieves a similar outcome.

If the employer has elected to include an in-plan Roth conversion provision in the plan, all employer contributions that are fully vested can be converted to Roth. The downside here is the conversion amount is subject to the 5-year tax period rule.

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