Tax-Free Roth 401(k) May Not be Tax-Free for Long

The Treasury Department and the Internal Revenue Service have proposed rules that if approved, will give taxpayers additional detail about sorting contributions to their 401(k) savings plans as if they were Roth IRAs, according to Dow Jones.

The Roth 401(k) allows taxpayers to contribute money to 401(k)s after tax, therefore allowing the funds to both grow and be withdrawn tax-free, reports Dow Jones.

However, the new rule would limit what the definition of "qualified distribution" is and only these types would be tax-free, ultimately redesigning the Roth 401(k).

A qualified distribution is defined in section 402A(d)(2) as a distribution that is made after completion of a specified five-year period and the satisfaction of other specified requirements. According to the IRS, this includes whether the distribution is: (1) is made on or after the date the employee attains age 591/2, (2) is made after the employee's death, or (3) is attributable to the employee's being disabled within the meaning of section 72(m)(7).

However, if a direct rollover is made from a designated Roth account under another plan, the five- taxable-year period for the recipient plan begins on the first day of the employee's taxable year for which the employee first had designated Roth contributions made to the other plan, if earlier.

Public comments on the proposed rules are open until April 26, 2006. The full proposal can be viewed at http://www.ustreas.gov/press/releases/reports/roth402a.pdf.

The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.