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Federal Withholding on an In-Plan Roth Conversion

“How do the federal withholding rules apply to an in-plan Roth conversion in a 401(k) plan?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • The federal withholding rules for in-plan conversions to a designated Roth account in a 401(k) plan are similar to the rules that generally apply for eligible rollover distributions that are rolled over directly to another eligible plan versus rolled over indirectly (i.e., within 60 days) (Internal Revenue Code Section 3405). The IRS has provided specific guidance for in-plan Roth conversions in Notice 2013-74 Q&A 4.
  • If the conversion of assets in-plan is done as a direct rollover to the designated Roth account, and the participant does not receive any of the assets, the plan sponsor should not withhold taxes. Neither can a participant request voluntary withholding under IRC Sec. 3402(p). Since a conversion is generally a taxable event, a plan participant making a direct in-plan Roth conversion may need to increase his or her withholding or make estimated tax payments to avoid an underpayment penalty from the IRS.
  • In contrast, if a plan participant receives a distribution in cash from the plan, the plan sponsor must withhold 20 percent federal income tax even if the participant later rolls over the distribution to a designated Roth account within 60 days. Because plan sponsors do not apply federal income tax withholding to a direct in-plan Roth conversion, a plan participant may need to increase his or her withholding or make estimated tax payments to avoid an underpayment penalty from the IRS.

Conclusion

Because plan sponsors do not apply federal income tax withholding to a direct in-plan Roth conversion, a plan participant may need to increase his or her withholding or make estimated tax payments to avoid an underpayment penalty from the IRS.

 

 

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