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Roth 401(k) distributions.

Proposed regulations (REG-146459-05) provide further guidance and clarification on the taxation of distributions from designated Roth accounts under Sec. 401(k) and 403(b) plans. (For a discussion of the proposed regulations on designating elective contributions to a Sec. 401(k) plan as Roth contributions, see News Notes, Laffie, "Roth 401 (k)s," TTA, March 2006, p. 133.)

Designated Roth contributions allow employees to designate all or a portion of their elective contributions under a Sec. 401(k) or 403(b) annuity plan as Roth contributions. These contributions would receive tax treatment much like Roth IRA contributions (i.e., they would be contributed from after-tax income but later, "qualifying distributions" of the contributions plus earnings would be completely tax-free).

To be a qualified Roth distribution, the amount must meet certain requirements, which include having been held for five years and having been made after the participant reaches age 59 1/2, dies or becomes disabled. Roth distributions can only be rolled over to other Roth plans or IRAs.

If a distribution is not qualified, under Sec. 72 the distribution would be included in the distributee's gross income, to the extent allocable to income on the contract, and excluded from gross income to the extent allocable to investment in the contract (basis). The amount of a distribution allocable to investment in the contract is determined by applying the ratio of the investment in the contract to the account balance to the distribution. Note: this treatment differs from the taxation of nonqualified distributions from Roth IRAs, in which nonqualified distributions are treated as a return of contributions (and thus not includible in gross income) until all contributions have been returned as basis.

Separate accounting: Under Sec. 402A(b) (2) (A) and (B), separate "designated Roth accounts" must be established, and separate recordkeeping must be maintained for each account. Under the proposed regulations, these reporting and recordkeeping requirements will not become effective until tax years beginning after 2006. This delay gives plans sufficient time to develop systems to comply with these reporting requirements.
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Author:Laffie, Lesli S.
Publication:The Tax Adviser
Date:May 1, 2006
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