(b)lines Ask the Experts – What Types of Contributions Can Be Characterized as Roths?

Experts from Groom Law Group and Cammack Retirement Group answer questions concerning 403(b) plans and regulations.

“A public higher education organization operates a governmental 401(a) plan, 403(b) plan, and a 457(b) plan. Roth contributions are not permitted in any plans, but the plan sponsor is considering doing so. What types of contributions can be characterized as Roth contributions? For example, the 401(a) plan has mandatory employee contributions that are “picked-up” as pretax contributions under 414(h); could they be characterized as Roth contributions? And what about the auto-enrolled 403(b) plan—can employee deferrals be defaulted to Roth unless employees elect otherwise?”

Stacey Bradford, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

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A Roth contribution is a type of elective deferral that employees can make to their 401(k), 403(b) or governmental 457(b) retirement plan, meaning that in order to provide for designated Roth contributions, a plan must also offer traditional, pre-tax elective contributions. (And, generally, a governmental employer cannot offer a 401(k) plan with elective deferrals, except for some grandfathered plans.) If offered, an employee may irrevocably designate an elective deferral as an after-tax Roth contribution. Therefore, as mandatory employee contributions do not qualify as elective deferrals, contributions picked up by an employer cannot qualify as Roth contributions.

Roth contributions are subject to the Code section 402(g) limit when combined with pre-tax elective deferrals, a limit which is not applicable to picked up contributions. In addition, employees must be allowed to change their designation for future contributions, which runs counter to the rules of pick-ups that prohibit employee elections.

On the other hand, a 403(b) or governmental 457(b) plan can provide that employees who are automatically enrolled in the plan will be defaulted to Roth contributions. The plan must state how the employer will allocate automatic contributions between pre-tax elective contributions and designated Roth contributions, and if the plan defaults to Roth contributions, employees who have not made an affirmative election are deemed to have irrevocably designated contributions as Roth contributions.

We note that in-plan Roth conversions offer another option, as they allow for the conversion of additional types of contributions into Roth amounts. As with any change to your plan design, the implementation of any of these programs should be evaluated with outside counsel.

 

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

Do YOU have a question for the Experts? If so, we would love to hear from you! Simply forward your question to Rebecca.Moore@strategic-i.com with Subject: Ask the Experts, and the Experts will do their best to answer your question in a future Ask the Experts column.

Few 401(k) Participants Make Trades in July

Year-to-date, investors have favored fixed income on 186 trading days, or 86% of the trading days available, according to Alight Solutions.

Despite volatility, July was a slow trading month for 401(k) investors, according to the Alight Solutions 401(k) Index. July also marks the 18th month in a row that net trades have moved from equities to fixed income. Nineteen of the 22 trading days favored fixed income. On average, only 0.014% of 401(k) balances were traded daily, and there was only one above-normal trading day.

Year-to-date, investors have favored fixed income on 186 trading days, or 86% of the trading days available.

Asset classes with the most trading inflows in the month were bond funds (taking in 52% of the inflows, worth $189 million), international equity funds (14%, $52 million) and money market funds (12%, $43 million).

Asset classes with the most trading outflows were company stock (42%, $154 million), large U.S. equity funds (40%, $143 million) and small U.S. equity funds (9%, $33 million).

Asset classes with the largest percentage of total balances at the end of July were target-date funds (TDFs) (29%, $62.166 billion), large U.S. equity funds (25%, $54.291 billion) and stable value funds (10%, $21.188 billion). Asset classes with the most contributions in July were TDFs (47%, $511 million), large U.S. equity funds (20%, $220 million) and international funds (7%, $79 million).

Returns were very muted during the month, with large U.S. equities rising 1.4%, small U.S. equities up 0.6%, U.S. bonds up 0.2% and international equities down 1.2%.

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