Different Ways to Measure “5 Years” for Roth IRAs and Roth 401(k)s

by Lawrence J. Zeller, MSPA

If you’ve made contributions to Roth IRAs, you probably know that you didn’t get a tax deduction when you made the contribution. And you probably remember that you have to meet some rules in order avoid paying income tax on the earnings when you take a withdrawal.

In order to avoid paying taxes on your Roth IRA earnings, you first you must meet one of the following:

  1. be at least age 59-1/2;

  2. be totally disabled (under the Social Security definition of total disability);

  3. be a beneficiary of a Roth IRA owner who died; or

  4. be a qualified first-time homebuyer ($10,000 limit).

In addition, you must meet the “5 year rule”, which means that “5 tax years must pass from when the first contribution is made to a Roth IRA”. Thanks to quirky tax rules, there are some interesting twists to how the “5 years” is determined for this rule.

  1. The 5 year period starts on the first day of the year for which the contribution is made. For example, if you made a contribution for the 2015 tax year on April 15, 2016 (the last possible day), it’s treated as having been made on January 1, 2015. Withdrawals could be made as early as January 1, 2020 --only 3 years, 8-1/2 months after the contribution was made, and still meet the 5 year rule!

  2. All Roth IRAs are aggregated, so if any one of them qualifies for the 5 year rule, all of them do. So here’s a practical idea that might be worth considering. If you have only traditional IRAs, consider taking a small amount, say $100, and converting it to Roth, even if you’re not otherwise interested in making Roth IRAs or taking distributions right now. That will get the 5 year rule started for all future Roth IRAs for you, and if you change your mind later about making Roth contributions, you’ll have a head start on meeting the 5 year rule.

  3. Designated Roth accounts under a company’s 401(k) or other retirement plan are a different story. These are counted separately from Roth IRAs, so meeting the 5 year rule in a Roth IRA doesn’t help meet it in your company’s retirement plan. Also, each employer plan is subjected to its own 5 year rule, so meeting it in one plan doesn’t help meet it in another plan. And finally, if you roll a Roth 401(k) account into a Roth IRA, the 5 year rule starts all over again. Even if you had met the 5 year rule in the Roth 401(k), you now start all over again to meet it in the Roth IRA. But if you roll money from one Roth 401(k) to another Roth 401(k), the combined balance is based on whichever account has been around longer for purposes of meeting the 5-year rule.

  4. When converting from a traditional pre-tax IRA to a Roth IRA (or doing a Roth conversion within a 401(k) Plan), the 5 year period starts in the calendar year during which the conversion occurs. Each conversion has its own 5 year clock. If there are multiple conversions, withdrawals are deemed to come from the oldest conversion first (the “FIFO” or “first-in, first-out” rule), which is helpful, because those are the likeliest to meet the 5 year rule.

  5. Withdrawals from a traditional pre-tax IRA are subject to income tax and a 10% penalty if withdrawn before age 59-1/2. But if you convert a pre-tax IRA to a Roth IRA, once you meet the 5-year rule, you can withdraw the amounts attributable to the contribution without penalty. Earnings, however, would still be taxable and subject to the early withdrawal penalty.

Confused? Can’t say I blame you! Tax rules are frequently very detailed, and lengthy tax regulations often result in the rules not applying the way you think they might. As you can see, 5 years can mean a lot of different things regarding Roth withdrawals.

Always feel free to check with us here at Preferred Pension Planning when you have questions about any type of retirement plans.

Why Do I Have To Re-Write My Plan Again?

By Michelle Glassman, ERPA, QPA

Over the next few months, many pension plan sponsors will be notified that their retirement plan document has to be rewritten. Many who receive this notification will ask “Why does the plan need to be rewritten?” And many will recall that it doesn’t seem like that long ago when the plan was last rewritten. This article will explain why the plan must be rewritten (also referred to as “restated”) and the rules for when the plan must be rewritten.

Pension Plan Document Are Legal Contracts

A plan document is a legal contract between the plan sponsor and the participants who receive benefits under the plan. A plan is required to be in writing, and the provisions are enforceable under law. If the plan contains outdated provisions, a problem arises because the participants have a claim based on the written document and the plan sponsor has to abide by the terms of the plan which may not be in compliance with current laws.

The Plan Document Must Comply With Current Laws

Quite often, Congress makes changes to the laws that govern the design and operation of pension plans. In addition, the IRS and the Department of Labor frequently issue regulations and rulings that change the way plans operate. These changes must be incorporated into the language of the plan in order for the plan to continue to retain its “tax-qualified” approval status. Before 2007, every time legislation was passed or regulations were issued that affected qualified plans, the plan document had to be amended or completely restated. Sometimes a law would have multiple provisions with different effective dates. This created much uncertainty and unnecessary costs for pension plan sponsors and the IRS who had to review the restated plans. In 2007, the IRS established a program under which all plans must be restated every five or six years (depending on the category of the plan, as explained below) to incorporate all laws and regulations enacted since the last restatement. Between restatements, the plan can rely on its most recent approval letter even if some of the new laws had not yet been included in the document.

Two Types of Plan Document Formats

Plan documents can be “pre-approved” or “individually designed.”

 -A pre-approved plan is one that has had its basic format submitted to the IRS in advance by the party drafting the plan, and as long as there have been no significant changes to the outline of the plan, any adopter of the pre-approved plan can rely on the plan’s basic approval letter. Pre-approved plans include both “prototype plans” and “volume submitter plans.”

 -An individually designed plan is written “from scratch” and is extremely flexible in that any provisions can be included in the document. However, individually designed plans are generally more expensive to draft and can only be submitted to the IRS for approval if it is the initial determination (a new plan) or the plan is terminating.

Pre-Approved Plan Restatements

Under the IRS program, pre-approved plans must be restated every six years. There are two sets of six-year cycles, one for defined contribution plans (which include 401(k) plans and profit sharing plans) and one for defined benefit plans (which include traditional defined benefit plans as well as cash balance plans). The first six-year cycle for pre-approved defined benefit plans ended April 30, 2012. That cycle required plans to incorporate the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 and became known as the “EGTRRA Restatement Cycle.” The new cycle for pre-approved defined benefit plans is being referred to as the “PPA Restatement Cycle” because it includes the provisions of the Pension Protection Act of 2006. The IRS has finalized their approval of the master documents which will be used to write these plans. Since IRS approval in May 2018, plan sponsors were given two years to rewrite their plans using a pre-approved document.

What’s Next

At Preferred Pension Planning Corporation, we use a pre-approved volume submitter plan document. This allows the employer to have flexibility in plan design while minimizing the cost of drafting the plan document and eliminating the need to submit the plan to IRS for approval, which in most cases, is no longer permitted. Whether a pre-approved plan or an individually designed plan document is used, all sponsors of qualified retirement plans are responsible for making sure their plan document stays in compliance with the most recent laws and regulations. Watch for more information concerning the PPA restatement.

Pension Changes In The 2018 Budget Act


The Bipartisan Budget Act of 2018 was signed into law on February 9, 2018. There are several provisions in this act that affect pension plans, but the most notable changes are those relating to hardship distributions. There are three changes to the hardship rules contained in the Budget Act. Good news: they are all helpful in facilitating hardship distributions. These changes become effective for Plan Years that begin after December 31, 2018, so they won't take effect until 2019.

1. Currently, a participant in a plan who receives a hardship distribution may not make elective deferral contributions for at least 6 months after the withdrawal. This 6 month waiting period has been eliminated.

2. In order to be eligible to take a hardship distribution, a participant must not be able to obtain funds from other sources. If the plan allows for participant loans, the participant must take any available plan loans before receiving the hardship distribution, unless repayment of the loan would create an additional hardship. The Budget Act eliminates the requirement to take a plan loan before receiving a hardship.

3. Hardship distributions can currently be made only from elective deferral contributions and (to the extent allowed by the plan) any discretionary employer contributions, but may not include any earnings on the deferrals. The Budget Act changes this rule so that participants will also be able to take hardship distributions from all contribution sources, including “Safe Harbor” matching and non-elective employer contributions, plus earnings on all sources.

Most plan documents will require an amendment in order to take advantage of these changes. We will reach out to all plan sponsors who may be affected by this change later this year with guidance on any action that may be required.

If you have any questions about how these new provisions will affect you and your employees, please don’t hesitate to give us a call at 908-575-7575 or email info@preferredpension.com.

Retirement Plan Provisions in the New Tax Law


New tax laws often include provisions that relate to retirement plans. The new tax law passed in December 2017 is no different. Often, the changes are not favorable to retirement plans, because Congress has a nasty habit of cutting back the tax benefits of retirement plan benefits and contributions to make up for tax cuts in other areas. But fortunately, this time retirement plans seem to have escaped any significant changes. Hooray! The only changes in the new tax bill that directly impact retirement plans are as follows:

Repeal of Recharacterization of Roth Conversions

If you make a contribution to a conventional IRA, you can change your mind and have it transferred to a Roth IRA, or vice versa. This is called a Roth conversion.

Under previous rules, if you change your mind again and want to reverse the Roth conversion, you can do that any time up until the due date of your tax return. This is called "recharacterization" of the conversion.

The new tax law repeals the rule allowing you to recharacterize conversions. So once you transfer your IRA contribution from a regular IRA to a Roth, that's it – there is no undoing the conversion.

Extension of Time to Roll Over Loan Offsets When an employee receives a distribution from a plan on termination of employment or plan termination, any outstanding loans are "offset" against the full account balance, and the net amount is distributed. For example, suppose Riley has a balance in her 401(k) plan of $30,000, and has an unpaid balance on her loan of $10,000 in addition. Riley would be taxed on her full account balance of $40,000, which includes the value of her outstanding loan being "offset" against her account, but only $30,000 is distributed.

In order to avoid having to pay tax on the value of the loan offset, Riley could either (a) repay the loan to the plan before the distribution is made, then roll it over to an IRA or another retirement plan; or (b) if she rolls over the balance to an IRA or another retirement plan before she repays the loan, Riley could repay the loan to the IRA or new plan within 60 days of the loan offset.

The new tax law extends the 60-day period mentioned above. Riley now has until the due date of the filing of her income tax return (including extensions) for the year the offset occurred to repay the loan.

Distributions to participants in Federal disaster areas A participant whose principal residence was located in a Federally-declared disaster area during 2016, and who sustained an economic loss due to the disaster, is eligible for certain tax relief on distributions up to $100,000 from retirement plans.

Pass Through Income The new law includes a deduction for "pass-through income" for certain types of businesses. Under the new tax law, these businesses could be placed in a situation where the income tax benefits of making contributions are curtailed by having a larger tax on the benefits when they are distributed. This is clearly unfair, and we believe it was unintended because the tax bill was rushed through Congress without full discussion. It may be advisable to wait for clarification or changes to the rule before making any decisions on this issue.

Please let us know if you have questions regarding any of these new rules. We'll be glad to review them with you!

"Do you know where your participants are?"


Those of us who have been around since the late 1960s remember the iconic television public service announcement that was preceded an announcement of the time: "It's 10 p.m., do you know where your children are?" The implication was that if you didn't know where your children were, perhaps your parenting skills needed improvement and your children could be in danger. A new announcement from the DOL has us asking, "Do you know where your former employees are?" In particular, those who still have money left in your company's retirement plan. If you don't, there could be serious consequences.

The DOL has announced a country-wide initiative to send requests to retirement plan sponsors, asking for current contact information for selected participants. Sponsors who cannot give accurate information may subject their plan to an audit. Importantly, the DOL considers it a breach of fiduciary responsibility if the plan sponsor cannot contact participants who have balances in the plan, unless a diligent effort has been made to locate them.

What constitutes a "diligent effort?" There is no definitive list, but here are some actions that we believe will show a diligent effort.

  1. Send a letter by certified mail, or a recognized delivery service like UPS, DHL, or Federal Express, to the employee's last known address, informing them about their retirement account and asking for them to make a decision as to its disposition. If the letter is returned because the address is incorrect, save the returned letter with a record of the date it was sent and returned.

  2. Attempt to contact the participant by phone, email, or text. Save a copy of the attempt to contact (either a paper or electronic record is sufficient).

  3. Do an internet search using Google, Bing, Yahoo, ask.com, or a similar search engine. There are also free "people search" sites like http://www.ussearch.com.

  4. Search for the participant on Social Media such as Facebook, LinkedIn, Twitter, etc.

  5. If you have a beneficiary form from the participant, try to contact the beneficiaries for information about the participant. If you remember the participant's spouse, children, parents, other relatives or friends, attempt to contact them for information.

  6. Check with your payroll company to find out if they offer a service to locate former employees. If checks were being directly deposited, the payroll company may be able to contact the former employee through their bank.

  7. Hire a commercial locator service such as http://www.employeelocator.com.

Even if you have followed these procedures, there is no guarantee that you'll locate the person. But keep the documentation so that you have proof you made a diligent effort to locate the participant and avoid a costly fiduciary breach.