Benefits Plans - roth savings Plans - frequently asked questions

• General
• Distributions
• Rollovers
• Age 59½
• Minimum Distribution and Passing Assets to Heirs

General

What is an after-tax Roth contribution?
A Roth contribution is an elective deferral that you irrevocably designate as an after-tax contribution.  It is subject to all applicable wage-withholding requirements when it is deducted from your paycheck.  Since the entire amount is included in your gross income, there is no tax savings during the year it is deducted from your paycheck.  You do not pay taxes on the contribution when you receive it as a distribution and the earnings may be tax-free.  In contrast, tax-deferred contributions are not subject to income tax when it taken from your paycheck and are not included in your gross income.  However, you pay taxes on the contribution and earnings at the point you take a distribution.

Are the Roth 403(b) SRA and Roth 457(b) new types of plans?
No.  The after-tax Roth is a new option for the existing 403(b) SRA and 457(b) plans.

When are the Roth SRA and Roth 457(b) effective?
January 1, 2013

When can I sign up for a Roth SRA and/or 457(b)?
You can use Self Service > Benefits on Wolverine Access to make your elections according to these deadlines:  http://www.benefits.umich.edu/plans/retire/onlinedeadlines.html

Are there income limits on who can have a Roth 403(b) SRA or Roth 457(b)?
No.  The Roth IRA is not available to those with income above a certain threshold.  However, the Roth 403(b) and Roth 457(b) do not have this IRS income restriction.

Who is eligible?
All faculty and staff eligible for the 403(b) SRA and 457(b) may make after-tax Roth contributions to these plans.  This is generally a 1% or greater appointment of at least four months duration with eligible earned compensation that is subject to federal income tax withholding and issued on a University of Michigan W-2.

Can I designate all my future 403(b) SRA and/or 457(b) contributions as after-tax Roth?
Yes.  You may elect to have all future contributions as after-tax Roth, all tax-deferred or a combination of both.  You may also make both tax-deferred and after-tax Roth contributions in the same tax year.

After I make an after-tax Roth contribution, can I then change it retroactively to tax-deferred?
No.  An election to make a contribution as after-tax Roth is irrevocable.  You may have future contributions tax-deferred but once the election has been made to designate a contribution as after-tax Roth you cannot change it to tax-deferred retroactively.

Does the after-tax Roth raise the annual contribution limits for retirement savings plans?
No.  The limit for 457(b) contributions and for 403(b) contributions is $17,500 for each plan if you are under age 50 and $23,000 if you are 50 or older.  The after-tax Roth option does not change these limits; it just means that you may designate some or all of your contributions to these plans as after-tax.

I already have a U-M 403(b) SRA and/or U-M 457(b).  Do I open a new account for the Roth?
No.  When you choose to make Roth contributions, TIAA-CREF and/or Fidelity Investments will simply track your after-tax contributions and associated earnings separately within your existing U-M account(s).

Can I make after-tax Roth contributions on the 5% I contribute to the Basic Retirement Savings Plan?
No.  After-tax contributions are only being made available to the 403(b) SRA and 457(b) plans.  After-tax Roth contributions are only permitted on voluntary (elective) contributions per federal regulations.  The Basic Retirement Plan is mandatory at age 35 or older, with a 100% appointment effort and two or more years of eligible service.  This prevents the university from offering after-tax Roth contributions on mandatory contributions for compulsory participants in the Basic Retirement Plan.

Who may benefit from a Roth 403(b) or Roth 457(b)?

• Individuals who want tax-free income and want to leave tax-free assets to heirs.
• Young faculty and staff who have a long retirement horizon that will allow time to amass significant tax-free assets.
• Individuals not eligible for an after-tax Roth IRA due to IRS income restrictions.
• Individuals who want to make Roth 403(b) and 457(b) contributions that exceed the Roth IRA limit of only $5,500.
• Individuals who believe their income tax rates will rise in the future.
• Individuals who want tax diversification of having both after-tax and tax-deferred assets as a hedge against potential tax increases.

Distributions

Can I withdraw Roth accumulations anytime since they were made from after-tax income?
No.  The same events that allow a distribution on the tax-deferred 403(b) SRA (termination, hardship, disability, in-service starting at age 59½) and the 457(b) Deferred Compensation Plan (termination or in-service starting at age 70½) apply to the after-tax Roth.

Can I take a loan from Roth accumulations in the 403(b) SRA and/or 457(b)?
You can take a loan from Roth accumulations in your 403(b) SRA and/or 457(b) account with Fidelity Investments.  Roth accumulations may be used to calculate the amount available for a loan from TIAA-CREF; however, the Roth amounts cannot be taken as a loan from TIAA-CREF.

When are Roth distributions tax-free?
Distributions of after-tax Roth contributions are tax-free since taxes were paid when taken from your paycheck.  Earnings on after-tax Roth contributions are tax-free when they are a qualified distribution.

What is a qualified Roth distribution?
A qualified distribution is generally a distribution that is made after a 5-taxable-year period of participation and is either:

• made on or after the date you attain age 59½,
• made after your death, or
• attributable to your being disabled, as defined by Internal Revenue Code (IRC) Section 72(m)(7).

If a distribution is made to your alternate payee (in the case of a divorce) or beneficiary, then your age, death or disability is used to determine whether the distribution is qualified.  However, when the alternate payee or a surviving spouse rolls over the distribution to his or her own employer’s designated Roth account their own age, death or disability is used to determine if the distribution is qualified.

What happens to a Roth distribution that is nonqualified?
The contribution portion of the distribution is tax-free since taxes were already paid at the time it was deducted from your paycheck.  However, any earnings will be taxed as ordinary income.

What is the 5-taxable-year period of participation? How is it calculated?
The 5-taxable-year period of participation begins on the first day of your taxable year for which you first made designated Roth contributions to the plan. It ends when five consecutive taxable years have passed.  Once the period does begin, it continues to run even if you do not make any additional contributions.  In the absence of information to the contrary, it is assumed that a participant’s taxable year is the calendar year. 

There is also a special provision for reemployed veterans who perform qualified military service as defined by Internal Revenue Code Section 414(u).  Their Roth contributions generally are treated as made in the year of qualified military service to which the contributions relate, even if the contribution is actually made when the veteran later returns to employment.

If you make a direct rollover from a designated Roth account under another plan, the 5-taxable-year period for the recipient plan begins on the first day of the taxable year that you made designated Roth contributions to the other plan, if earlier.

What types of distributions cannot be qualified and must be included in gross income?
The following types of distributions from a designated Roth account are not qualified distributions:

• Corrective distributions of elective deferrals in excess of the Internal Revenue Code limits.
• Corrective distributions of excess contributions or excess aggregate contributions.
• Deemed distributions under §72(p) (where you default on repayment of a plan loan).

What happens if I take a distribution from my designated Roth account before the end of the 5-taxable-year period?
If you take a distribution from your designated Roth account before the end of the 5-taxable-year period, it is a nonqualified distribution.  Therefore, you must include the earnings portion of the nonqualified distribution in gross income and will be subject to income tax. However, the basis (or after-tax contributions) portion of the nonqualified distribution is not included in gross income since taxes were already paid when deducted from your paycheck.

Is a distribution from my designated Roth account for reasons beyond my control (e.g., involuntary discharge) a qualified distribution even though it doesn't meet the criteria for a qualified distribution?
No, if you have not held the account for more than 5 years and if the distribution is not made after death, disability, or age 59 ½, then the distribution is not a qualified distribution.  Termination of employment (whether voluntary or involuntary) does not constitute a qualified distribution.  In addition, disability, death or attainment of age 59½ is not a qualified distribution if the account has not also been held for at least 5 years.

Rollovers

Can I roll over distributions from my U-M Roth 403(b) SRA or Roth 457(b) to another employer's designated Roth 401(k)/403(b)/governmental 457(b) or into a Roth IRA?
Yes. However, because a distribution from a designated Roth account consists of both tax-deferred accumulations (earnings on the after-tax Roth contributions) and after-tax Roth contributions, it must be rolled over into a designated Roth account in another plan through a direct rollover.  If the distribution is made directly to you and then you roll it over within 60 days, the after-tax Roth contribution portion cannot be rolled over to another designated Roth 401(k)/403(b)/governmental 457(b) account, but can be rolled over into a Roth IRA.

If only a portion of the distribution is rolled over, the rolled over portion is treated as consisting first of the amount of the distribution that is includible in gross income.  Alternatively, you may roll over the taxable portion of the distribution to a 401(a) or 403(b) plan’s designated Roth account within 60 days of receipt. However, your period of participation under the distributing plan is not carried over to the recipient plan for purposes of measuring the 5-taxable-year period under the recipient plan.

How is the 5-taxable-year period calculated when I roll over a distribution from my U-M designated Roth 403(b) or Roth 457(b) to a Roth IRA?
The period that the rolled-over funds were in the U-M Roth 403(b) SRA and/or Roth 457(b) does not count toward the 5-taxable-year period for determining qualified distributions from the Roth IRA.  However, if you had contributed to any Roth IRA in a prior year, the 5-taxable-year period for determining qualified distributions from a Roth IRA is measured from the earlier contribution. Therefore, if the earlier contribution was made more than 5 years ago and you are over 59½ a distribution of amounts attributable to a rollover contribution from a designated Roth account would be a qualified distribution from the Roth IRA.

 How is the 5-taxable-year period calculated with regards to a rollover?

• Direct rollovers from one Roth 401(k)/403(b)/governmental 457(b) account to another Roth 401(k)/403(b)/governmental 457(b) account – the participant receives credit in the recipient plan for their period of participation in the distributing plan.  In other words, the five-year period is measured from the earliest year in which the participant made contributions to either plan.
• 60-day rollovers from one Roth 401(k)/403(b)/governmental 457(b) account to another Roth 401(k)/403(b)/governmental 457(b) account - the participant does not receive credit in the recipient plan for their period of participation in the distributing plan.
• Any type of rollover to a Roth IRA – the participant does not receive credit in the Roth IRA for their period of participation in the distributing plan.  If an individual had already established a Roth IRA, the start of the five-year period for the Roth IRA would apply to any distributions from that account, including any rollover amounts.
• Direct rollover from a participant’s Roth 401(k)/403(b)/governmental 457(b) account to an alternate payee or to a spousal beneficiary’s Roth account in a plan maintained by the alternate payee’s employer - the five-year period under the recipient plan begins on the earlier of 1) the date of the employee’s period of participation under the distributing plan, or 2) the date the alternate payee or beneficiary’s Roth account began under the recipient plan.   However, the alternate payee’s or spousal beneficiary’s own age, death or disability is used to determine whether a distribution from the recipient plan is qualified.

Age 59½

Does the IRS 10% penalty apply to Roth distributions made prior to age 59½?
The penalty does not apply to distributions made from a 457(b) plan, whether tax-deferred or after-tax Roth.  The 403(b) Supplemental Retirement Account or SRA is subject to the penalty based on the source of the distribution.  Distributions of after-tax Roth contributions are tax-free.  However, nonqualified distributions of earnings are subject to taxes and may be subject to the 10% penalty if made prior to age 59½ under the 403(b) SRA.

Does age 59½ serve as a test for determining benefits?
Yes.  Age 59½ is one of the criteria for determining if a Roth distribution is qualified to be tax free (along with death or disability and having participated in the Roth for at least five years).  Age 59½ is also the threshold for determining if a taxable distribution is subject to an IRS 10% early withdrawal penalty.  Note the following examples:

Example #1

• Bob is 50 years old and has been contributing to the U-M 403(b) Roth SRA for five years.
• He terminates employment and elects a distribution of his U-M Roth SRA.
• The Roth distribution is not qualified because he is under 59½, even though he has been participating in the account for 5 years.
• The Roth earnings are subject to income tax since the distribution is not qualified.
• The Roth earnings are also subject to the 10% IRS early withdrawal penalty since Bob is under age 59½ when he takes the distribution.

Example #2

• Lynn is 50 years old and has been contributing to the U-M 403(b) Roth SRA for two years.
• She terminates employment and is disabled according to IRC Section 72(m)(7).
• She elects a distribution of her U-M Roth 403(b) SRA.
• Being disabled is one of the triggering events to be a qualified Roth distribution.  However, it is not qualified because she only has two years of participating in the Roth and not the minimum of 5 years. 
• The Roth earnings are subject to income tax since the distribution is not qualified.
• The Roth earnings are not subject to the 10% IRS early withdrawal penalty even though she is under age 59½ because disability is one of several exceptions to the penalty.  Other exceptions to the 10% early withdrawal penalty are also available.

Minimum Distribution and Passing Assets to Heirs

Are Roth amounts subject to minimum distribution at age 70½?
Yes.  However, if you roll over the balance in your U-M Roth 403(b) SRA or Roth 457(b) to a Roth IRA before the calendar year in which you reach age 70½, the minimum distributions are not required.  You are then able to postpone distributions from the Roth IRA indefinitely during your lifetime.

How can I pass Roth assets to my heirs tax-free?
Assets from your Roth SRA and/or Roth 457(b) may be rolled over into a Roth IRA.  Assets in a Roth IRA are never required to be taken as a distribution in your lifetime.  You can pass Roth assets to your heirs, who can then take qualified distributions without paying income taxes.

Are Roth assets subject to estate taxes?
Roth assets may be subject to estate taxes, but can be mitigated with proper estate planning.  Please note that this is different than Roth assets being subject to income taxes. 

This information is based on the University of Michigan’s current understanding of highly-complex Internal Revenue Code (IRC) and U.S. Treasury Department regulations.  It is provided for general informational purposes only.  The University of Michigan does not provide (nor is this intended to constitute) tax, legal, accounting, estate planning or investment advice.  It is the responsibility of the individual to address questions or concerns to a qualified professional.