Summary of Final Roth 401(k) Regulations Following a long tradition, the Internal Revenue Service (“IRS”) issued final Roth 401(k) regulations late in the year, 12/30/2005. These final regulations, which apply to Roth 401(k) contributions may begin for plan years starting on or after 1/1/2006. Roth 403(b) contributions may begin at that same time. Items of note on our first reading are: 1. Preamble, page two, end of carryover paragraph - In discussing similarities and differences of Roth IRAs and Roth 401(k) accounts, the government notes that Roth IRAs have specific distribution ordering rules, i.e., after-tax contributions get distributed first, but Roth 401(k) rules does not have such ordering rules and, therefore, Code section 72 rules apply. What this means is that partial distributions, i.e., not all of the Roth 401(k) account, will have to be allocated between tax-free distribution of after-tax contributions and taxable distribution of earnings if the Roth 401(k) account has not been in existence for five calendar years. That is the period of time necessary to get a completely tax-free distribution, but remember that normal distribution restrictions (death, disability, severance of employment) still apply to Roth 401(k) deferrals and earnings the same as pre-tax deferrals. 2. We recommend to those with a need to understand these rules to read the entire copy of the final regulations. However, we understand that some of you do not enjoy reading regulations like we do. So, for those folks we recommend reading the material under the "Explanation of Provisions" starting on page two. 3. Preamble, page two, “Rules Relating to Designated Roth Contributions,” last paragraph - Explains that final regulations clarify that a 401(k) plan may not only offer Roth 401(k) contributions, i.e., pre-tax deferrals must also be available. 4. Preamble, page three, "Separate Accounting Requirement" - Gets close to addressing the separate accounting requirement and whether or not that requirement requires separate annuity contracts for Roth 401(k) contributions where such annuities provide for any enhanced death benefits such as a guaranteed return of premiums paid. This may be addressed in Roth 403(b) regulations which we expect to be proposed later this year. 5. Preamble, page three, "Other Rules," first paragraph - Clarifies that Roth 401(k) contributions may be treated as age-50 catch-up contributions and serve as the basis for a participant loan. In the third paragraph, it is clarified that plans with automatic enrollment provisions may require those deferrals be Roth 401(k) contributions. In the fourth paragraph on page seven, it provides some flexibility with respect to Roth 401(k) accounts with less than $200. That account may be treated as a separate account compared to the rest of a participant's accounts in the plan and the plan does not have to permit a direct rollover of that small amount. The real issue, however, is whether or not an automatic IRA rollover applies to Roth 401(k) account separately if less than $1,000 with respect to forced distributions vs. automatic IRA rollovers. It appears to us that determination must still be made on the basis of all plan accounts. This may change with Roth 401(k) distribution rules that are expected shortly. 6. Preamble, page four, first full paragraph - Clarifies that a plan need not permit a HCE to elect a corrective contribution of an ADP excess contribution from pre-tax deferrals or Roth 401(k) deferrals. The plan may specify how this is handled. 7. Preamble, page four, "Additional Plan Terms" - Clarifies that a plan may permit a participant to elect the source of a distribution from the plan, i.e., distributed in whole or in part from pre-tax or Roth 401(k) contributions. These rules must be in the plan document. 8. Preamble, page four, "Certain Issues Addressed in Proposed Regulations" - Confirms our understanding that distribution rules will be in proposed regulations to be issued soon. 9. 1.401(k)-1(f)(2) - While certainly not much clearer than before or in the statute, we think that the sentence, "In addition, gains, losses, and other credits or charges must be separately allocated on a reasonable and consistent basis to the designated Roth account and other accounts under the plan." supports our position that pre-tax deferrals and Roth 401(k) deferrals may be held in a single annuity contract and any allocation of enhanced death benefits, such as guarantee of premiums paid, need only be reasonably allocated between those different accounts. We think that our current practice, as we understand it, of allocating those enhanced death benefits based on the applicable account values at the time the enhanced death benefit is paid is reasonable. 10. 1.401(k)-1(f)(3) - Keeps the rule when these regulations were proposed that Roth 401(k) contributions are subject to required minimum distribution ("RMD") rules even though Roth IRAs are not. We expect to hear a great deal more about the ability to "game" the system by taking a distribution from a Roth 401(k) account and doing a direct rollover to a Roth IRA in order to avoid RMD requirements.