Designated Roth Accounts Under Section 402A, 21103-21116 [E7-8125]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 72, Number 82 (Monday, April 30, 2007)]
[Rules and Regulations]
[Pages 21103-21116]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-8125]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9324]
RIN 1545-BF04


Designated Roth Accounts Under Section 402A

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final Regulations.

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SUMMARY: This document contains final regulations under sections 
401(k), 402(g), 402A, and 408A of the Internal Revenue Code (Code) 
relating to designated Roth accounts. These final regulations provide 
guidance concerning the taxation of distributions from designated Roth 
accounts under qualified cash or deferred arrangements under section 
401(k). These final regulations will affect administrators of, 
employers maintaining, participants in, and beneficiaries of section 
401(k) and section 403(b) plans, as well as owners and beneficiaries of 
Roth IRAs and trustees of Roth IRAs.

DATES: Effective Date: These final regulations are effective April 30, 
2007.
    Applicability Date: These regulations generally apply to taxable 
years beginning on or after January 1, 2007. For dates of 
applicability, see Sec. Sec.  1.401(k)-1(f)(6), 1.402A-1, A-15, 1.402A-
2, A-4 and 1.408A-10, A-6.

FOR FURTHER INFORMATION CONTACT: R. Lisa Mojiri-Azad or William D. 
Gibbs at 202-622-6060, or Cathy A. Vohs, 202-622-6090 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
was reviewed and approved by the Office of Management and Budget (OMB) 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)) under control number OMB-1545-1992.
    The collection of information in these final regulations is in 26 
CFR 1.402A-2. This information is required to comply with the separate 
accounting and recordkeeping requirements of section 402A. This 
information will be used by the IRS and employers maintaining 
designated Roth accounts to insure compliance with the requirements of 
section 402A. The collection of information is required to obtain a 
benefit. The likely recordkeepers are state or local governments, 
business or other for-profit institutions, nonprofit institutions, and 
small businesses or organizations.
    The estimated annual burden per respondent under control number 
OMB-1545-1992 is 2.3 hours.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains final regulations under section 402A, and 
amendments to regulations under sections 401(k), 402(g), and 408A of 
the Internal Revenue Code. Section 402A, which sets forth rules for 
designated Roth contributions, was added to the Code by section 617(a) 
of the Economic Growth and Tax Relief Reconciliation Act of 2001, 
Public Law 107-16 (115 Stat. 103) (EGTRRA), effective for taxable years 
beginning after December 31, 2005. These final regulations also reflect 
certain provisions of the Pension Protection Act of 2006, Public Law 
109-280, (120 Stat. 780) (PPA '06), including section 811 of PPA '06, 
which repealed the sunset provisions of EGTRRA with respect to section 
402A.
    Section 401(k) sets forth rules for qualified cash or deferred 
arrangements under which an employee may make an election between cash 
and an employer contribution to a plan qualified under section 401(a). 
Section 403(b) permits a similar salary reduction agreement under which 
payments are made to a section 403(b) plan. Section 402(e)(3) provides 
that an amount is not

[[Page 21104]]

includible in an employee's income merely because the employee has an 
election whether these contributions will be made to the trust or 
annuity or received by the employee in cash.
    Amounts contributed pursuant to these qualified cash or deferred 
arrangements and salary reduction agreements are defined in section 
402(g)(3) as elective deferrals. Section 402(g)(1) provides a limit on 
the amount of elective deferrals that may be excluded from an 
employee's income for a taxable year. Section 402(g)(2) provides for 
the distribution of elective deferrals that exceed the annual limit on 
elective deferrals (an excess deferral).
    A designated Roth contribution is an elective deferral, as 
described in section 402(g)(3)(A) or (C), that has been designated by 
an employee, pursuant to section 402A, as not excludable from the 
employee's gross income. Under section 402A(b)(2), designated Roth 
contributions must be maintained by the plan in a separate account (a 
designated Roth account).
    Under section 402(a), a distribution from a plan qualified under 
section 401(a) is taxable under section 72 to the distributee in the 
taxable year distributed. However, pursuant to section 402A(d)(1), a 
qualified distribution from a designated Roth account is excludable 
from gross income. A qualified distribution is defined in section 
402A(d)(2) as a distribution that is made after completion of a 
specified 5-year period and the satisfaction of other specified 
requirements.
    If the distribution is not a qualified distribution, pursuant to 
section 72, the distribution is included in the distributee's gross 
income to the extent allocable to income on the contract and excluded 
from gross income to the extent allocable to investment in the contract 
(basis). The amount of a distribution allocated to investment in the 
contract is generally determined by applying to the distribution the 
ratio of the investment in the contract to the account balance.
    Section 402(c) provides rules under which certain distributions 
from a plan qualified under section 401(a) may be rolled over into 
another eligible retirement plan. In such a case, the distribution is 
not currently includible in the distributee's gross income. Under 
section 402(c)(2), as amended by section 822 of PPA '06, to the extent 
some or all of the distribution from a plan qualified under section 
401(a) would not have been includible in gross income if it were not 
rolled over, that portion of the distribution can only be rolled over 
into an individual retirement plan, or through a direct rollover to 
another qualified plan or section 403(b) plan that agrees to separately 
account for such rolled over amounts. Section 403(b)(8)(B) provides 
that the rules of section 402(c)(2) also apply for purposes of the 
rollover rules under section 403(b)(8).
    Under section 402(c)(8) and 402A(c)(3), a distribution from a 
designated Roth account can be rolled over only to another designated 
Roth account or to a Roth IRA. Under section 408A, a Roth IRA is a type 
of individual retirement plan (IRA) under which contributions are never 
deductible and qualified distributions are excludable from gross 
income. Section 408A(d)(4) sets forth special ordering rules for the 
return of basis in the case of a distribution from a Roth IRA. Under 
the section 408A(d)(4) ordering rules, in a nonqualified distribution 
from a Roth IRA, basis is recovered before income.
    Section 617(d) of EGTRRA amended section 6051(a)(8) to require the 
reporting of designated Roth contributions on Form W-2, ``Wage and Tax 
Statement,'' and added a new subsection (f) to section 6047 to require 
plan administrators or other responsible persons of section 401(k) or 
403(b) plans to make such returns and reports regarding designated Roth 
contributions to the Secretary of the Treasury and such other persons 
the Secretary may prescribe.
    Final regulations under section 401(k) were issued on December 29, 
2004 (69 FR 78144). Those final regulations reserved Sec.  1.401(k)-
1(f) for special rules for designated Roth contributions. On January 3, 
2006, final regulations were issued that fill in that reserved 
paragraph and provide additional rules applicable to designated Roth 
contributions (71 FR 6). The provisions of the final regulations under 
section 401(k) regarding designated Roth contributions do not address 
the taxability of distributions from designated Roth accounts or the 
reporting requirements that apply to contributions of designated Roth 
contributions or distributions from the accounts.
    On January 26, 2006, a notice of proposed rulemaking (REG-146459-
05) under section 402A was published in the Federal Register (71 FR 
4322). The proposed regulations also would have provided guidance with 
respect to designated Roth contributions under section 403(b) plans by 
amending the proposed regulations under section 403(b), published in 
the Federal Register on November 16, 2004 (69 FR 67075). This guidance 
has not been finalized in this Treasury Decision, but will instead be 
included in the final regulations under section 403(b). Written 
comments responding to the notice of proposed rulemaking under section 
402A were received. A public hearing was held on July 26, 2006. After 
consideration of all comments, these final regulations adopt the 
provisions of the proposed regulations with certain modifications, the 
most significant of which are highlighted below.
    These final regulations under section 402A are intended to provide 
comprehensive guidance on the taxation of distributions from designated 
Roth accounts under section 401(k) and section 403(b) plans. These 
regulations also provide guidance on the reporting requirements with 
respect to these accounts and include amendments to the provisions of 
the final section 401(k) regulations relating to designated Roth 
contributions. In addition, these final regulations include amendments 
to the regulations under section 402(g) issued in 1991 in order to 
reflect the enactment of section 402A (as well as other statutory 
changes since those regulations were issued) and to make changes to 
conform the regulations under section 402(g) to the final section 
401(k) regulations. These final regulations also add a new Sec.  
1.408A-10 to the existing regulations under section 408A for Roth IRAs 
(Sec.  1.408A-1 through 9) issued in 1999 to reflect the interaction 
between section 408A and section 402A.

Explanation of Provisions

Overview

    These final regulations, like the proposed regulations, provide 
guidance on the taxation of distributions from designated Roth accounts 
and other related issues. A designated Roth account is a separate 
account under a section 401(k) plan or section 403(b) plan to which 
designated Roth contributions are made, and for which separate 
accounting of contributions, gains, and losses are maintained. These 
final regulations retain the rule from the proposed regulations that 
any transaction or accounting methodology involving an employee's 
designated Roth account and any other accounts under the plan or plans 
of an employer that has the effect of directly or indirectly 
transferring value from another account into the designated Roth 
account violates the separate accounting requirement under section 
402A.
    The taxation of a distribution from a designated Roth account 
depends on whether or not the distribution is a qualified distribution. 
A qualified

[[Page 21105]]

distribution from a designated Roth account is not includible in the 
employee's gross income. A qualified distribution is generally a 
distribution that is made after a 5-taxable-year period of 
participation and that either (1) is made on or after the date the 
employee attains age 59\1/2\, (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). In response to comments, these final 
regulations clarify that, in the case of distribution to an alternate 
payee or beneficiary, the age, death or disability of the participant 
are used to determine whether the distribution is qualified. The only 
exception is in the case of a rollover by an alternate payee or 
surviving spouse to a designated Roth account under a plan of his or 
her own employer.

Determination of 5-Taxable-Year Period for Qualified Distributions

    In order for a distribution from a designated Roth account to be a 
qualified distribution and thus not includible in gross income, a 5-
taxable-year requirement must be satisfied. These final regulations, 
like the proposed regulations, reflect the rule in section 402A that 
the 5-taxable-year period during which a distribution is not a 
qualified distribution begins on the first day of the employee's 
taxable year for which the employee first had designated Roth 
contributions made to the plan and ends when 5 consecutive taxable 
years have been completed. However, if a direct rollover is made from a 
designated Roth account under another plan, the 5-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.
    Commentators inquired as to when designated Roth contributions made 
by a reemployed veteran for a year of qualified military service 
pursuant to section 414(u), are treated as made for purposes of the 5-
taxable-year period of participation. In response to these comments, 
the final regulations provide that designated Roth contributions made 
by a reemployed veteran are treated as made in the taxable year with 
respect to which the contributions relate. Reemployed veterans may 
identify the year for which a contribution is made for other purposes, 
such as for entitlement to a match, and the treatment for the five year 
period of participation rule follows that identification. Absent such 
an identification, for purposes of determining the first year of the 
five years of participation under section 402A(d)(2)(B), the 
contribution is treated as made in the veteran's first taxable year in 
which the veteran's qualified military service begins, or if later, the 
first taxable year in which designated Roth contributions could be made 
under the plan.
    Commentators asked how the 5-taxable-year period of participation 
rule applies to a required minimum distribution made for an earlier 
year, such as a distribution made on April 1 following the year an 
employee attains age 70\1/2\. They also asked whether, if payments 
under an annuity stream commence before a qualifying event, the 
payments after the qualifying event could be qualified distributions 
(assuming the 5-year period of participation is satisfied). The 
determination of whether a payment is a qualified distribution is 
determined based upon the actual year of the payment from the account 
and does not take into account whether the payment is part of a series 
of distributions or whether the payment is attributable to a prior 
calendar year.
    In response to comments, these final regulations provide that 
certain contributions do not start the 5-taxable-year period of 
participation. For example, a year in which the only contributions 
consist of excess deferrals will not start the 5-taxable-year period of 
participation. Further, excess contributions that are distributed to 
prevent an ADP failure also do not begin the 5-taxable-year period of 
participation. Finally, contributions returned to the employee pursuant 
to section 414(w) also do not start the 5-taxable-year period of 
participation.

Taxation of Nonqualified Distributions

    These final regulations retain the rules from the proposed 
regulations for taxation of nonqualified distributions and provide that 
a distribution from a designated Roth account that is not a qualified 
distribution is taxable to the distributee under section 402 (or 
section 403(b)(1)), treating the designated Roth account as a separate 
contract under section 72. In applying that treatment, the portion of 
any distribution that is includible in gross income as an amount 
allocable to income on the contract and the portion not includible in 
income as an amount allocable to investment in the contract is 
generally determined under section 72(e)(8) (or, in the case of an 
amount received as an annuity, section 72 (b) or (d), as applicable).
    Some commentators requested that the special ordering rules in 
section 408A(d), which provide that the first distributions from a Roth 
IRA are a return of contributions (and thus not includible in gross 
income) until all contributions have been returned as basis, be applied 
to distributions from a designated Roth account. They noted that a pro 
rata basis recovery rule in section 72 is difficult to explain to 
employees receiving a hardship distribution from a designated Roth 
account because the entire distribution reduces the amount of elective 
contributions (including designated Roth contributions) available for 
hardship distribution while, for purposes of determining the amount 
includible in income under sections 402(a) and 72, only a portion of 
the distribution is treated as recovery of basis attributable to the 
designated Roth contributions.
    As noted in the preamble to the proposed regulations, because 
section 402A does not provide that the special ordering rules of 
section 408A(d) apply to distributions from designated Roth accounts, 
these final regulations do not apply those special ordering rules. 
Although designated Roth contributions to a designated Roth account 
bear some similarity to contributions to a Roth IRA (e.g., 
contributions to either type of account are after-tax contributions, 
and qualified distributions from either type of account are excludable 
from gross income), there are many differences between these types of 
arrangements. The only special rule under section 402A for nonqualified 
distributions from a designated Roth account is that the account is 
treated as a separate contract for purposes of section 72.
    Thus, these final regulations do not apply the basis recovery rules 
in section 408A to distributions from designated Roth accounts. 
Furthermore, the limit on elective contributions available for hardship 
distribution is an aggregate limit that takes into account both pre-tax 
elective contributions and designated Roth contributions. For example, 
an employee could take all hardship distributions from the pre-tax 
account, even though part of the amount available for hardship is 
attributable to designated Roth contributions. Thus, the amount of 
elective deferrals available for distribution from a designated Roth 
account on account of hardship generally would be a different amount 
than the total designated Roth contributions even if the ordering rule 
in section 408A(d)(4) applied to distributions from designated Roth 
accounts.

Rollover of Designated Roth Contributions

    As described above in the Background section of this preamble, 
section

[[Page 21106]]

402(c)(2), after amendment by section 822 of PPA `06, provides that, if 
a portion of the distribution from a plan qualified under section 
401(a) is not includible in income (determined without regard to the 
rollover), that portion of the distribution can only be rolled over by 
a direct rollover of the distribution to another qualified plan, or to 
a section 403(b) plan, that provides for separate accounting for 
amounts transferred (and earnings thereon) including separate 
accounting for the portion of such distribution which is includible in 
gross income and the portion of such distribution that is not so 
includible. Alternatively, the distribution can be rolled over to an 
IRA in either a 60-day rollover or direct rollover.
    Section 402A(c)(3) provides that a rollover contribution of a 
distribution from a designated Roth account may only be made to the 
extent it is otherwise allowable. Section 402(c)(2) provides rules 
regarding when a rollover contribution of amounts not includable in 
gross income are allowable. As noted in the preamble to the proposed 
regulations, the IRS and Treasury Department believe that the rules in 
section 402(c)(2) relating to the rollover of a distribution of an 
amount not includable in gross income apply to a distribution from a 
designated Roth account.\1\ Thus, these regulations retain the rule in 
the proposed regulations that, in order to roll over any portion of the 
basis in a designated Roth account into a designated Roth account under 
another plan, the rollover of the distribution must be accomplished 
through a direct rollover (i.e., a rollover to another designated Roth 
account is not available for the portion of the distribution not 
includible in gross income if the distribution is made directly to the 
employee). However, for purposes of these regulations, the requirement 
that the receiving plan separately account for designated Roth 
contributions that are rolled over has been eliminated because such 
contributions are independently subject to the separate account 
requirement of Treas. Reg. Sec.  1.401(k)-1(f).\2\
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    \1\ For distributions from designated Roth accounts, there is 
the same need for proper accounting of investment in the contract as 
for distributions from other accounts that include after-tax 
contributions. In addition, it is necessary to track whether the 
employee has satisfied the 5-year rule for qualified distributions.
    \2\ The proposed regulations would have reflected the rule in 
section 402(c)(2) prior to amendment by PPA `06 that limited 
rollovers of distributions from qualified plans that are not 
includible in gross income to direct rollovers to other qualified 
trusts and not to section 403(b) plans. These final regulations do 
not retain this restriction on rollovers because of the amendments 
to section 402(c) made by section 822 of PPA `06.
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    In response to comments, the final regulations clarify that, for 
purposes of these regulations, if any amount is paid as a direct 
rollover, that amount is treated as a separate distribution from any 
amount paid directly to the distributee for purposes of applying 
section 402(c)(2). Finally, to insure that there is proper accounting 
in the recipient plan, as described under the heading Reporting and 
Recordkeeping, these final regulations retain the provision in the 
proposed regulations requiring the distributing plan making the direct 
rollover is required to report the amount of the investment in the 
contract and the first year of the 5-year period to the recipient plan 
so that the recipient plan will not need to rely on information from 
the distributee.
    In response to comments, the definition of designated Roth account 
has been revised to clarify that the definition only includes accounts 
under a plan to which designated Roth contributions are made in lieu of 
elective contributions or deferrals. Thus, the final regulations 
clarify that a distribution from a designated Roth account may only be 
rolled over to a section 401(k) plan or section 403(b) plan if that has 
a designated Roth program.
    As in the proposed regulations, the final regulations provide that 
if the entire amount of a distribution from a designated Roth account 
is rolled over to another designated Roth account, the amount of the 
rollover contribution allocated to investment in the contract in the 
recipient designated Roth account is the amount that would not have 
been includible in gross income (determined without regard to section 
402(e)(4)) if the distribution had not been rolled over. Thus, if an 
amount that is a qualified distribution is rolled over, the entire 
amount of the rollover contribution is allocated to investment in the 
contract. In response to comments, the final regulations clarify that, 
if the entire account balance of a designated Roth account is rolled 
over to another designated Roth account, and, at the time of the 
distribution, the investment in the contract exceeds the balance in the 
designated Roth account, the investment in the contract in the 
distributing plan is included in the investment in the contract of the 
recipient plan.\3\
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    \3\ If the investment in the contract exceeds the account 
balance and the entire account balance is distributed (and not 
rolled over), see Rev. Rul. 72-305, 1972-1 C.B. 116, for guidance 
concerning a deduction for the difference.
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    If a distribution from a designated Roth account is made to an 
employee, the employee is still able to roll over the entire amount (or 
any portion thereof) into a Roth IRA within a 60-day period. Under 
section 402(c)(2), if only a portion of the distribution is rolled 
over, the portion that is rolled over is treated as consisting first of 
the amount of the distribution that is includible in gross income. 
These final regulations, like the proposed regulations, provide that 
the income limits for contributions for Roth IRAs do not apply for this 
purpose.
    Alternatively, the proposed regulations provided that the employee 
is permitted to roll over the taxable portion of the distribution to a 
designated Roth account within a 60-day period. In such a case, 
additional reporting is required from the recipient plan, as described 
below under the heading Reporting and Recordkeeping. In addition, the 
employee's period of participation under the distributing plan is not 
carried over to the recipient plan for purposes of determining whether 
the employee satisfies the 5-taxable-year requirement under the 
recipient plan. Commentators objected to this different treatment for 
indirect rollover contributions claiming that it reduces portability. 
The IRS and Treasury Department believe that this rule is more 
consistent with the statutory language and will further encourage 
direct rollover of distributions from designated Roth accounts which 
will reduce leakage of these distributions from retirement savings 
solution. Thus, this rule is retained in the final regulations. 
However, the final regulations provide that such an indirect rollover 
contribution starts the 5-taxable-year period of participation under 
the receiving plan for a participant who has made no prior designated 
Roth contributions to that plan.

Determination of 5-Taxable-Year Period After a Rollover to a Roth IRA

    Section 402A and section 408A each provide for a 5-taxable-year 
period that must be completed in order for a distribution from a 
designated Roth account or a Roth IRA to be a qualified distribution. 
However, each of these sections contains different rules for 
determining when the 5-taxable-year requirement is satisfied. 
Generally, under section 402A, satisfaction of the 5-taxable-year 
requirement with respect to a designated Roth account under a plan is 
based on the years since a designated Roth contribution was first made 
by the employee under that plan. In contrast, the 5-year period under 
section 408A begins with the first

[[Page 21107]]

taxable year for which a contribution is made to any Roth IRA.
    Commentators suggested that, if a distribution from a designated 
Roth account to an individual is rolled into a Roth IRA, the individual 
receive credit under the 5-year rule in section 408A for the years 
since the individual first made a contribution to a designated Roth 
account. As noted in the preamble to the proposed regulations, the IRS 
and Treasury Department do not believe that the Code provides for this 
interaction between the two 5-year rules. Thus, these final regulations 
retain the rule under the proposed regulations that the 5-taxable-year 
period described in section 402A and the 5-taxable-year period 
described in section 408A(d)(2)(B) are determined independently. Thus, 
in the case of a rollover of a distribution from a designated Roth 
account maintained under a section 401(k) or 403(b) plan to a Roth IRA, 
the final regulations, like the proposed regulations, provide that the 
period that the rolled-over funds were in the designated Roth account 
does not count towards the 5-taxable-year period for determining 
qualified distributions from the Roth IRA. However, if an individual 
had established a Roth IRA in a prior year, the 5-year period for 
determining qualified distributions from a Roth IRA that began as a 
result of that earlier Roth IRA contribution applies to any 
distributions from the Roth IRA (including a distribution of an amount 
attributable to a rollover contribution from a designated Roth 
account).
    If a nonqualified distribution from a designated Roth account is 
rolled over into a Roth IRA, the portion of the distribution that 
constitutes a nontaxable return of investment in the contract is 
treated as basis in the Roth IRA. However, the final regulations, like 
the proposed regulations, provide that, if a qualified distribution 
from a designated Roth account is rolled over into a Roth IRA, the 
entire amount of the distribution will be treated as basis in the Roth 
IRA. As a result, a subsequent distribution from the Roth IRA in the 
amount of the rollover would be treated as a tax-free return of basis 
regardless of whether the individual had maintained a Roth IRA for 5 
years (although the investment return on that amount earned in the Roth 
IRA would not be excluded from income when distributed unless the 
distribution satisfied the requirements for a qualified distribution 
from a Roth IRA). Similar to the case of a rollover to a designated 
Roth account, if the entire account balance of a designated Roth 
account is distributed and some or all of the distribution is rolled 
over to a Roth IRA, and, at the time of the distribution, the 
investment in the contract exceeds the balance in the designated Roth 
account, the investment in the contract in the distributing plan is 
included in the amount treated as a contribution to the Roth IRA.

Certain Amounts Not Qualified Distributions

    Section 1.402(c)-2, A-4, provides a list of amounts that are not 
treated as eligible rollover distributions and are instead currently 
includible in income. These final regulations, like the proposed 
regulations, provide that these same amounts also cannot be qualified 
distributions. Distributions described in A-4(a) (distribution of 
elective deferrals in excess of the section 415 limits), (b) 
(corrective distribution of excess deferrals), and (c) (corrective 
distribution of excess contributions or excess aggregate 
contributions), have statutorily specified tax treatments. In the case 
of a deemed distribution under section 72(p) or the cost of current 
life insurance protection, an actual amount has not in fact been 
distributed. In the case of distributions of dividends deductible under 
section 404(k), section 72(e)(5)(D) and Sec.  1.404(k)-1T provide that 
these amounts are treated as paid under a separate contract providing 
only for payment of deductible dividends. However, if a dividend 
described in section 404(k) has been reinvested in accordance with 
section 404(k)(2)(iii)(II), then a distribution of the reinvested 
amount can be a qualified distribution.
    In response to comments regarding hardship distributions, the final 
regulations clarify that an amount is not precluded from being a 
qualified distribution merely because it is described in section 
402(c)(4) as an amount not eligible for rollover. Thus, hardship 
distributions and required minimum distributions are not precluded from 
being qualified distributions. Similarly, payments in a stream of 
periodic payments are not precluded from being qualified distributions 
merely because they are described in section 402(c)(4)(A).

Distribution of Employer Securities and NUA

    The final regulations retain the rules of the proposed regulations 
relating to the distribution of employer securities and the application 
of the net unrealized appreciation election of section 402(e)(4). If a 
qualified distribution includes employer securities, the distribution 
is not includible in gross income and the basis of each security in the 
hands of the distributee is the fair market value of the security on 
the date of the distribution. In such a case, the distributee will 
receive capital gains treatment at the time of any future disposition 
of the security, to the extent of any post-distribution appreciation. 
If a distribution with respect to employer securities is not a 
qualified distribution, the rules of section 402(e)(4) apply in the 
same manner as to any other distribution except that the designated 
Roth account is treated as a separate contract.
    Some commentators inquired how these rules apply to the portion of 
a nonqualified distribution that exceeds the basis of the employer 
stock at the time of the distribution to the extent not includible in 
gross income as a return of the employee's designated Roth 
contributions. As explained in Rev. Rul. 74-398, 1974-2 C.B. 136, the 
basis of the stock at the time of the disposition will be increased to 
reflect such amount, so that such amount will not be subsequently taxed 
as appreciation at the time of a subsequent disposition of the stock.

Annuity Contracts

    As noted above, in the Overview section of this preamble, these 
final regulations retain the rule from the proposed regulations that 
any transaction or accounting methodology involving an employee's 
designated Roth account and any other accounts under the plan or plans 
of an employer that has the effect of directly or indirectly 
transferring value from another account into the designated Roth 
account violates the separate accounting requirement under section 
402A. Commentators asked for additional guidance on how this 
requirement is satisfied for separate accounts maintained within a 
single annuity contract, in particular how to allocate charges for 
guarantees under the contract which apply to the total of all accounts 
under the contract. The IRS and Treasury Department believe that it may 
be difficult for a single contract to have combined guarantees that 
apply to both accounts without the potential for a prohibited transfer 
of value between the accounts, and have not issued guidance on how to 
account for these guarantees (including related charges). However, this 
issue will continue to be considered by the IRS and Treasury 
Department. Therefore, the regulations authorize the Commissioner to 
provide additional guidance with respect to separate accounting within 
an annuity contract.

[[Page 21108]]

    In response to comments, these final regulations clarify that, as 
previously indicated in Sec.  1.402(c)-2, A-10(a), a distribution of an 
annuity contract from a designated Roth account is not a distribution 
event for purposes of section 402 or 402A. Thus, in such case, only 
distributions from the annuity contract are treated as distributions 
for those purposes. The determination of whether a distribution is a 
qualified or nonqualified distribution is made at the time of the 
distribution from the contract.

Reporting and Recordkeeping

    These final regulations retain the rule of the proposed regulations 
that the plan administrator or other responsible party with respect to 
a plan with a designated Roth account is responsible for keeping track 
of the 5-taxable-year period for each employee and the amount of 
designated Roth contributions made on behalf of such employee. In 
addition, the plan administrator or other responsible party of a plan 
directly rolling over a distribution is required to provide the plan 
administrator of the recipient plan (that is, the plan accepting the 
eligible rollover distribution) with a statement indicating either the 
first year of the 5-taxable-year period for the employee and the 
portion of such distribution attributable to basis or that the 
distribution is a qualified distribution. If the distribution is not a 
direct rollover to a designated Roth account under another eligible 
plan, the plan administrator or responsible party must provide to the 
employee, upon request, this same information, except the statement 
need not indicate the first year of the 5-taxable-year period. The 
statement is required to be provided within a reasonable period 
following the direct rollover (or employee request), but in no event 
later than 30 days following the direct rollover (or employee request), 
and the plan administrator or other responsible party for the recipient 
plan is permitted to rely on these statements. If this information is 
provided on a statement attached to the check issued to the employee, 
this requirement would be satisfied.
    As noted in the preamble, to the extent that a portion of a 
distribution is includible in income (determined without regard to the 
rollover), if any portion of that distribution is rolled over to a 
designated Roth account by the distributee rather than by direct 
rollover, the plan administrator of the recipient plan must notify the 
IRS of its acceptance of the rollover contribution. The final 
regulations clarify that this reporting is only required to the extent 
provided in Forms and Instructions. Such Instructions will specify the 
address to which the notification must be sent and will require the 
following information: (1) The employee's name and social security 
number; (2) the amount rolled over; (3) the year in which the rollover 
contribution was made; and (4) such other information as the 
Commissioner may prescribe in order to determine that the amount rolled 
over is a valid rollover contribution. Thus, until relevant Forms and 
Instructions are released, no reporting is required.
    With respect to other reporting, generally, the same reporting 
requirements apply to plans with designated Roth accounts as apply to 
other plans. A contribution to and a distribution from a designated 
Roth account must be reported on Form W-2 and Form 1099-R, 
``Distributions From Pensions, Annuities, Retirement or Profit-Sharing 
Plans, IRAs, Insurance Contracts, etc.,'' respectively, in accordance 
with the instructions thereto. An employee has no reporting obligation 
with respect to designated Roth contributions under a section 401(k) or 
403(b) plan. However, an employee rolling over a distribution from a 
designated Roth account to a Roth IRA should keep track of the amount 
rolled over in accordance with the instructions to Form 8606, 
``Nondeductible IRAs.''

Designated Roth Contributions as Excess Deferrals

    Even though designated Roth contributions are not excluded from 
income when contributed, they are treated as elective deferrals for 
purposes of section 402(g). Thus, to the extent total elective 
deferrals for the year exceed the section 402(g) limit for the year, 
the excess amount can be distributed by April 15th of the year 
following the year of the excess without adverse tax consequences. 
However, if such excess deferrals are not distributed by April 15th of 
the year following the year of the excess, these final regulations, 
like the proposed regulations, provide that any distribution 
attributable to an excess deferral that is a designated Roth 
contribution is includible in gross income (with no exclusion from 
income for amounts attributable to basis under section 72) and is not 
eligible for rollover. These regulations provide that if there are any 
excess deferrals that are designated Roth contributions that are not 
corrected prior to April 15th of the year following the excess, the 
first amounts distributed from the designated Roth account are treated 
as distributions of excess deferrals and earnings until the full amount 
of those excess deferrals (and attributable earnings) are distributed.

Gap Period Income

    In addition, these final regulations retain the rule in the 
proposed regulations which reflected the statutory provisions which 
require that any distribution of excess deferrals include the 
applicable earnings from the plan. Unlike the existing final 
regulations under section 402(g), the earnings include income for the 
period after the taxable year (gap period income). The calculation of 
gap period income is comparable to the calculation of the gap period 
income for excess contributions and excess aggregate contributions 
under the 2004 final regulations under section 401(k) and 401(m). Thus, 
gap period income must be included in the distribution of excess 
deferrals to the extent the employee is or would be credited with 
allocable gain or loss on those excess deferrals for the gap period if 
the total account were to be distributed. This gap period income rule 
applies to both pre-tax excess deferrals and designated Roth 
contributions and continues to apply even after the 2008 elimination of 
the rule for excess contributions and excess aggregate contributions 
under section 902(e)(3) of PPA '06.

Modifications to Final Roth 401(k) Regulations

    Some comments received in connection with the proposed regulations 
raised concerns not about those regulations but rather about the 
special rules for designated Roth contributions in Sec.  1.401(k)-1(f) 
that were finalized in TD 9237, published on January 3, 2006 (71 FR 6). 
In response to those comments these final regulations make two changes 
to those special rules. First, these regulations clarify and expand the 
rule in Sec.  1.401(k)-1(f)(3)(ii) to provide that the balance of a 
participant's designated Roth account and a participant's other 
accounts under the plan are treated as accounts held under two separate 
plans (within the meaning of section 414(l)) for purposes of applying 
not only the special rule in A-11 of Sec.  1.401(a)(31)-1 for de 
minimis distributions (reasonably expected to total less than $200) but 
also both the automatic rollover rules for mandatory distributions 
under section 401(a)(31)(B) and the rules in A-9 and A-10 of Sec.  
1.401(a)(31)-1 on the extent to which plans must allow split 
distributions. Thus, for example, if a participant has less than $1,000 
in the participant's designated Roth account

[[Page 21109]]

and less than $1,000 in the participant's other accounts, the plan will 
not need to provide the participant with an automatic rollover with 
respect to the designated Roth account or the other accounts even if 
the total accrued benefit of the participant under the plan exceeds 
$1,000.
    Second, in response to comments about compensation provided to 
certain foreign missionaries, the regulations are modified to require 
that an employer treat designated Roth contribution as not excludible 
from gross income as elective deferrals rather than treated as 
includible in gross income. As a result, if section 72(f)(2) applies to 
a contribution, an employee will have basis as a result of the 
contribution to the extent that contribution would have been excludible 
from gross income even if paid directly to the employee and such amount 
can be treated as a designated Roth contribution even though such 
amount is income that is not includible in taxable income. Thus, 
compensation for foreign missionaries is not precluded from being 
contributed to a designated Roth account merely because the 
compensation would not have been includible in gross income if paid 
directly. Finally, the regulations clarify that, for self-employed 
individuals, the requirement that a designated Roth contribution not be 
excludible from gross income as an elective deferral for being a 
designated Roth contribution is only satisfied if the self-employed 
individual does not claim a deduction for the contribution.
    Commentators inquired as to whether catch-up contributions may be 
designated Roth contributions. Catch-up contributions are treated the 
same as any other elective deferrals and, thus, a participant's catch-
up contributions may either be pre-tax elective deferrals or designated 
Roth contributions.
    Finally, these final regulations revise the special rules for 
designated Roth contributions in Sec.  1.401(k)-1(f) to reflect the 
repeal in PPA '06 of the sunset of the provisions relating to 
designated Roth contributions.

Effective Date

    Section 402A applies to employees' taxable years beginning on or 
after January 1, 2006. These final regulations under section 402A are 
generally applicable for taxable years beginning on or after January 1, 
2007. However, certain provisions in these final regulations under 
section 402A are applicable at the same time as section 402A. These 
include the clarification that the separate accounting requirement does 
not permit any transaction or accounting methodology that transfers 
value between designated Roth accounts and other accounts under a plan 
and the rules relating to rollovers to designated Roth accounts and 
Roth IRAs. Similarly, these final regulations under section 408A are 
applicable at the same time as section 402A. These final regulations 
also address the treatment of rollover contributions to Roth IRAs and 
designated Roth accounts.
    The final regulations under section 402(g) relating to designated 
Roth contributions also are applicable at the same time as section 
402A. Thus, these final regulations are applicable for excess deferrals 
for taxable years beginning on or after January 1, 2006. However, 
unlike the proposed regulations, the rule in these final regulations 
requiring distribution of gap period income on excess deferrals applies 
to excess deferrals for taxable years beginning on or after 2007, which 
are generally distributed on or after January 1, 2008.

Special Analyses

    It has been determined that these final regulations are not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that 5 U.S.C. 553(b) does not apply to these regulations. It 
is hereby certified that the collection of information in these 
regulations will not have a significant economic impact on a 
substantial number of small entities. This certification is based on 
the fact that most small entities that will maintain a designated Roth 
account already use a third party provider to administer the plan and 
the collection of information in these regulations, which is required 
to comply with the separate accounting and recordkeeping requirements 
of section 402A(b), will only minimally increase the third party 
provider's administrative burden with respect to the plan. Therefore, 
an analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) 
is not required. Pursuant to section 7805(f) of the Code, the proposed 
regulations preceding these final regulations were submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on their impact on small business.

Drafting Information

    The principal authors of these regulations are R. Lisa Mojiri-Azad, 
Bill Gibbs and Cathy Vohs, Office of Division Counsel/Associate Chief 
Counsel (Tax Exempt and Government Entities). However, other personnel 
from the IRS and Treasury Department participated in the development of 
these regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.402A-1 is also issued under 26 U.S.C. 402A * * *


0
Par. 2. Section 1.401(k)-0 is amended as follows:
0
1. The entries for 1.401(k)-1(f)(2), (3), (4) and (5) are revised.
0
2. The entry for 1.401(k)-1(f)(6) is added.


Sec.  1.401(k)-0  Table of contents.

* * * * *


Sec.  1.401(k)-1  Certain cash or deferred arrangements.

* * * * *
    (f) * * *
    (1) In general.
    (2) Inclusion treatment.
    (3) Separate accounting required.
    (4) Designated Roth contributions must satisfy rules applicable 
to elective contributions.
    (i) In general.
    (ii) Special rules for direct rollovers.
    (5) Rules regarding designated Roth contribution elections.
    (i) Frequency of elections.
    (ii) Default elections.
    (6) Effective date.


0
Par. 3. Section 1.401(k)-1(f) is amended as follows:
0
1. Revise paragraph (f)(1)(ii) and (iii).
0
2. Redesignate paragraphs (f)(2) through (5) as (f)(3) through (6).
0
3. Add a new paragraph (f)(2).
0
4. Revise the first sentence of newly redesignated paragraph (f)(3) and 
add a sentence at the end.
0
5. Revise the last sentence of newly redesignated paragraph (f)(4)(ii).
0
6. Revise newly redesignated paragraph (f)(6).
    The addition and revision to Sec.  1.401(k)-1 read as follows:


Sec.  1.401(k)-1  Certain cash or deferred arrangements.

* * * * *
    (f) Special rules for designated Roth contributions.
    (1) * * *

[[Page 21110]]

    (ii) Treated by the employer as not excludible from the employee's 
gross income (in accordance with paragraph (f)(2) of this section);
    (iii) Maintained by the plan in a separate account (in accordance 
with paragraph (f)(3) of this section).
    (2) Inclusion treatment. An elective contribution is generally 
treated as not excludible from gross income if it is treated as 
includible in gross income by the employer (e.g., by treating the 
contribution as wages subject to applicable income tax withholding). 
However, in the case of a self-employed individual, an elective 
contribution is treated as not excludible from gross income only if the 
individual does not claim a deduction for such amount. If an elective 
contribution would not have been includible in gross income if the 
amount had been paid directly to the employee (rather than being 
subject to a cash or deferral election), the elective contribution is 
nevertheless permitted to be a designated Roth contribution, provided 
the employee is entitled to treat the amount as an investment in the 
contract pursuant to section 72(f)(2).
    (3) Separate accounting required. Under the separate accounting 
requirement of this paragraph (f)(3), contributions and withdrawals of 
designated Roth contributions must be credited and debited to a 
designated Roth account maintained for the employee and the plan must 
maintain a record of the employee's investment in the contract (that 
is, designated Roth contributions that have not been distributed) with 
respect to the employee's designated Roth account. * * * See A-13 of 
Sec.  1.402A-1 for additional requirements for separate accounting.
    (4) * * *
    (ii) * * * Moreover, a participant's designated Roth account and 
the participant's other accounts under a plan are treated as accounts 
held under two separate plans (within the meaning of section 414(l)) 
for purposes of applying the automatic rollover rules for mandatory 
distributions under section 401(a)(31)(B)(i)(I) and the special rules 
in A-9 through A-11 of Sec.  1.401(a)(31)-1.
* * * * *
    (6) Effective date. Section 402A and the provisions of this section 
1.401(k)-1(f) apply to taxable years beginning after December 31, 2005.
* * * * *

0
Par. 4. Section 1.402(g)-1 is amended as follows:
0
1. Revise the second sentence and add a third sentence to paragraph 
(a).
0
2. Add new paragraphs (b)(5) and (b)(6).
0
3. Revise paragraph (d).
0
4. Revise paragraph (e)(2) introductory text.
0
5. Revise paragraph (e)(2)(i).
0
6. Revise the second sentence and add a new third sentence in paragraph 
(e)(3)(i)(A).
0
7. Revise paragraph (e)(5)(i).
0
8. Add a sentence after the last sentence in paragraph (e)(5)(ii).
0
9. Revise paragraph (e)(5)(iii).
0
10. Add paragraph (e)(5)(v).
0
11. Add paragraph (e)(8)(iv).
    The additions and revisions to Sec.  1.402(g)-1 read as follows:


Sec.  1.402(g)-1  Limitation on exclusion for elective deferrals.

    (a) In general. * * * Thus, an individual's elective deferrals in 
excess of the applicable limit for a taxable year (that is, the 
individual's excess deferrals for the year) must be included in gross 
income for the year, except to the extent the excess deferrals are 
comprised of designated Roth contributions, and thus, are already 
includible in gross income. A designated Roth contribution is treated 
as an excess deferral only to the extent that the total amount of 
designated Roth contributions for an individual exceeds the applicable 
limit for the taxable year or the designated Roth contributions are 
identified as excess deferrals and the individual receives a 
distribution of the excess deferrals and allocable income under 
paragraph (e)(2) or (e)(3) of this section.
    (b) * * *
    (5) Any designated Roth contributions described in section 402A 
(before applying the limits of section 402(g) or this section).
    (6) Any elective employer contributions to a SIMPLE retirement 
account, on behalf of an employee pursuant to a qualified salary 
reduction arrangement as described in section 408(p)(2) (before 
applying the limits of section 402(g) or this section).
* * * * *
    (d) Applicable limit--(1) In general. Except as provided under 
paragraph (d)(2) of this section, the applicable limit for an 
individual's taxable year is the applicable dollar amount set forth in 
section 402(g)(1)(B). This applicable dollar amount is increased for 
the taxable year beginning in 2007 and later years in the same manner 
as the dollar amount under section 415(b)(1)(A) is adjusted pursuant to 
section 415(d). See Sec.  1.402(g)-2 for the treatment of catch-up 
contributions described in section 414(v).
    (2) Special adjustment for elective deferrals with respect to 
section 403(b) annuity contracts for certain long-term employees. The 
applicable limit for an individual who is a qualified employee (as 
defined in section 402(g)(7)(C)) and has elective deferrals described 
in paragraph (b)(3) or (5) of this section for a taxable year is 
adjusted by increasing the applicable limit otherwise determined under 
paragraph (d)(1) of this section in accordance with section 402(g)(7).
    (e) * * *
    (2) Correction of excess deferrals after the taxable year. A plan 
may provide that if any amount is an excess deferral under paragraph 
(a) of this section:
    (i) Not later than the first April 15 (or such earlier date 
specified in the plan) following the close of the individual's taxable 
year, the individual may notify each plan under which elective 
deferrals were made of the amount of the excess deferrals received by 
the plan. If any designated Roth contributions were made to a plan, the 
notification must also identify the extent, if any, to which the excess 
deferrals are comprised of designated Roth contributions. A plan may 
provide that an individual is deemed to have notified the plan of 
excess deferrals (including the portion of excess deferrals that are 
comprised of designated Roth contributions) to the extent the 
individual has excess deferrals for the taxable year calculated by 
taking into account only elective deferrals under the plan and other 
plans of the same employer and the plan may provide the extent to which 
such excess deferrals are comprised of designated Roth contributions. A 
plan may instead provide that the employer may notify the plan on 
behalf of the individual under these circumstances.
* * * * *
    (3) * * *
    (i) * * *
    (A) * * * If any designated Roth contributions were made to a plan, 
the notification must identify the extent to which, if any, the excess 
deferrals are comprised of designated Roth contributions. A plan may 
provide that an individual is deemed to have notified the plan of 
excess deferrals (including the portion of excess deferrals that are 
comprised of designated Roth contributions) for the taxable year 
calculated by taking into account only elective deferrals under the 
plan and other plans of the same employer and the plan may provide the 
extent to which such excess deferrals are comprised of designated Roth 
contributions. * * *
* * * * *

[[Page 21111]]

    (5) Income allocable to excess deferrals--(i) General rule. The 
income allocable to excess deferrals for a taxable year that begins on 
or after January 1, 2007 is equal to the sum of the allocable gain or 
loss for the taxable year of the individual and, to the extent the 
excess deferrals are or will be credited with gain or loss for the 
period after the close of the taxable year and prior to the 
distribution (the gap period) if the total account were to be 
distributed, the allocable gain or loss during that period. The income 
allocable to excess deferrals for a taxable year that begins before 
2007 is determined using the 1.402(g)-1(e)(5) (as it appeared in the 
April 1, 2006 edition of 26 CFR Part 1).
    (ii) Method of allocating income. * * * A plan will not fail to use 
a reasonable method for computing the income allocable to excess 
deferrals merely because the income allocable to excess deferrals is 
determined on a date that is no more than 7 days before the 
distribution.
    (iii) Alternative method of allocating taxable year income. A plan 
may determine the income allocable to excess deferrals for the taxable 
year by multiplying the income for the taxable year allocable to 
elective deferrals by a fraction. The numerator of the fraction is the 
excess deferrals by the employee for the taxable year. The denominator 
of the fraction is equal to the sum of:
    (A) The total account balance of the employee attributable to 
elective deferrals as of the beginning of the taxable year, plus
    (B) The employee's elective deferrals for the taxable year.
* * * * *
    (v) Alternative method for allocating taxable year and gap period 
income. A plan may determine the allocable gain or loss for the 
aggregate of the taxable year and the gap period by applying the 
alternative method provided by paragraph (e)(5)(iii) of this section to 
this aggregate period. This is accomplished by substituting the income 
for the taxable year and the gap period for the income for the taxable 
year and by substituting the elective deferrals for the taxable year 
and the gap period for the elective deferrals for the taxable year in 
determining the fraction that is multiplied by that income.
* * * * *
    (8) * * *
    (iv) Distributions of excess deferrals from a designated Roth 
account. The rules of paragraph (e)(8)(iii) of this section generally 
apply to distributions of excess deferrals that are designated Roth 
contributions and the attributable income. Thus, if a designated Roth 
account described in section 402A includes any excess deferrals, any 
distribution of amounts attributable to those excess deferrals are 
includible in gross income (without adjustment for any return of 
investment in the contract under section 72(e)(8)). In addition, such 
distributions cannot be qualified distributions described in section 
402A(d)(2) and are not eligible rollover distributions within the 
meaning of section 402(c)(4). For this purpose, if a designated Roth 
account includes any excess deferrals, any distributions from the 
account are treated as attributable to those excess deferrals until the 
total amount distributed from the designated Roth account equals the 
total of such deferrals and attributable income.
* * * * *

0
Par. 5. Sections 1.402A-1 and 1.402A-2 are added to read as follows:


Sec.  1.402A-1  Designated Roth Accounts.

    Q-1. What is a designated Roth account?
    A-1. A designated Roth account is a separate account under a 
qualified cash or deferred arrangement under a section 401(a) plan, or 
under a section 403(b) plan, to which designated Roth contributions are 
permitted to be made in lieu of elective contributions, that satisfies 
the requirements of Sec.  1.401(k)-1(f) (in the case of a section 
401(a) plan).
    Q-2. How is a distribution from a designated Roth account taxed?
    A-2. (a) The taxation of a distribution from a designated Roth 
account depends on whether or not the distribution is a qualified 
distribution. A qualified distribution from a designated Roth account 
is not includible in the distributee's gross income.
    (b) Except as otherwise provided in paragraph (c) of this A-2, a 
qualified distribution is a distribution that is both--
    (1) Made after the 5-taxable-year period of participation defined 
in A-4 of this section has been completed; and
    (2) Made on or after the date the employee attains age 59\1/2\, 
made to a beneficiary or the estate of the employee on or after the 
employee's death, or attributable to the employee's being disabled 
within the meaning of section 72(m)(7).
    (c) A distribution from a designated Roth account is not a 
qualified distribution to the extent it consists of a distribution of 
excess deferrals and attributable income described in Sec.  1.402(g)-
1(e). See A-11 of this section for other amounts that are not treated 
as qualified distributions, including excess contributions described in 
section 401(k)(8), and excess aggregate contributions described in 
section 401(m)(8), and income, on any of these excess amounts.
    Q-3. How is a distribution from a designated Roth account taxed if 
it is not a qualified distribution?
    A-3. Except as provided in A-11 of this section, a distribution 
from a designated Roth account that is not a qualified distribution is 
taxable to the distributee under section 402 in the case of a plan 
qualified under section 401(a) and under section 403(b)(1) in the case 
of a section 403(b) plan. For this purpose, a designated Roth account 
is treated as a separate contract under section 72. Thus, except as 
otherwise provided in A-5 of this section for a rollover, if a 
distribution is before the annuity starting date, the portion of any 
distribution that is includible in gross income as an amount allocable 
to income on the contract and the portion not includible in gross 
income as an amount allocable to investment in the contract is 
determined under section 72(e)(8), treating the designated Roth account 
as a separate contract. Similarly, in the case of any amount received 
as an annuity, if a distribution is on or after the annuity starting 
date, the portion of any annuity payment that is includible in gross 
income as an amount allocable to income on the contract and the portion 
not includible in gross income as an amount allocable to investment in 
the contract is determined under section 72(b) or (d), as applicable, 
treating the designated Roth account as a separate contract. For 
purposes of section 72, designated Roth contributions are described in 
section 72(f)(1) or 72(f)(2), to the extent applicable.
    Q-4. What is the 5-taxable-year period of participation described 
in A-2 of this section?
    A-4. (a) The 5-taxable-year period of participation described in A-
2 of this section for a plan is the period of 5 consecutive taxable 
years that begins with the first day of the first taxable year in which 
the employee makes a designated Roth contribution to any designated 
Roth account established for the employee under the same plan and ends 
when 5 consecutive taxable years have been completed. For this purpose, 
the first taxable year in which an employee makes a designated Roth 
contribution is the year in which the amount is includible in the 
employee's gross income. Notwithstanding the preceding, however, a 
contribution that is returned as an excess deferral or excess 
contribution does not begin the 5 taxable-year period of participation. 
Similarly, a contribution returned as a permissible withdrawal under 
section

[[Page 21112]]

414(w) does not begin the 5 taxable-year period of participation.
    (b) Generally, an employee's 5-taxable-year period of participation 
is determined separately for each plan (within the meaning of section 
414(l)) in which the employee participates. Thus, if an employee has 
elective deferrals made to designated Roth accounts under two or more 
plans, the employee may have two or more different 5-taxable-year 
periods of participation, depending on when the employee first had 
contributions made to a designated Roth account under each plan. 
However, if a direct rollover contribution of a distribution from a 
designated Roth account under another plan is made by the employee to 
the plan, the 5-taxable-year period of participation begins on the 
first day of the emplo