5/5/2015

Case of the Week: Roth IRA vs. Designated Roth IRA

 

Responding to a question from an advisor in Massachusetts, the ERISA consultants at the Learning Center Resource Desk addressed a common inquiry involving Roth IRAs vs. designated Roth contributions in 401(k) plans.

The ERISA consultants at the Learning Center Resource Desk, which is available through Columbia Threadneedle Investments, regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with an advisor in Massachusetts is representative of a common inquiry involving Roth IRAs vs. designated Roth contributions in 401(k) plans. The advisor asked:

“What are the differences between Roth IRAs and designated Roth 401(k) accounts?”

Highlights of Discussion

The following chart summarizes the key differences:

Feature

 

Roth IRA

 

Designated Roth 401(k) account

Investment options

 

Generally unlimited, except for life insurance and certain collectibles

 

As specified by the plan

Eligibility for contribution

 

Must have earned income under $131,000 if single tax filer or under $193,000 if married filing joint tax return

 

401(k), 403(b) or governmental 457(b) plan with designated Roth contribution option; individual must meet eligibility requirements as specified by the plan

Contribution limit

 

$5,500 ($6,500 if age 50 or older)

 

$18,000 ($24,000 if age 50 or older)

Conversions

 

Anyone with eligible IRA or employer-plan assets may convert them to a Roth IRA

 

Plan permitting, anyone with eligible plan assets may convert them within the plan

Recharacterize conversion

 

Yes, within prescribed time frame

 

No

Required minimum distributions

 

Not during owner’s lifetime

 

Yes

Tax-free qualified distributions

 

After five years and age 59½; death; disability; or for first home purchase

 

Must have distribution-triggering event; then after five years and age 59½; death; or disability

Tax on nonqualified distributions

 

According to distribution ordering rules:
1. Contributions: always tax- and penalty-free
2. Conversions: on a first-in, first-out basis by year; always tax-free; possible penalty on taxable-at-conversion assets taken within five years of conversion
3. Earnings: taxed as ordinary income, subject to penalty unless exception applies

 

Withdrawals represent a pro-rata return of contributions and earnings in account; earnings taxable and subject to penalty unless an exception applies. See IRS Notice 2010-84 for rules applicable to the return of designated Roth 401(k) converted amounts

Timing of distributions

 

At any time

 

Following plan defined distribution-triggering event

Loans

 

No

 

Yes, if plan permits

Five-year holding period for qualified distributions

 

Begins January 1 of the year a contribution is made to any Roth IRA of the owner

 

Separate for each designated Roth 401(k) account; begins January 1 of the year a contribution is made to that account

Beneficiary

 

Anyone, but spousal consent required in community property states

 

Anyone, but spousal consent required


Conclusion

While both Roth IRAs and designated Roth 401(k) plan contributions offer the potential for tax-free withdrawals, there are several key differences between the two arrangements.  Whether one, the other or both may be right for a particular investor depends on the individual’s circumstances and goals, and ultimately should be determined based on a thorough conversation between the investor and his or her tax advisor.

The Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC (RLC), a third-party industry consultant that is not affiliated with Columbia Threadneedle. Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Columbia Threadneedle does not provide tax or legal advice. Consumers consult with their tax advisor or attorney regarding their specific situation. 

Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Columbia Threadneedle.

Columbia Threadneedle Investments (Columbia Threadneedle) is the global brand name of the Columbia and Threadneedle group of companies.

© 2015 Columbia Management Investment Advisers, LLC. Used with permission.