What Is Section 402A of the Internal Revenue Code?
Learn how Section 402A of the tax code provides a framework for post-tax savings, offering a different approach to your workplace retirement tax strategy.
Section 402A of the Internal Revenue Code is the federal law authorizing “Designated Roth Accounts” within certain employer-sponsored retirement plans. This provision allows employees to contribute after-tax income to their retirement savings. Unlike traditional pre-tax contributions that lower current taxable income, Roth contributions provide an alternative approach to tax planning for retirement.
Designated Roth Accounts and Contributions
A Designated Roth Account is a feature that can be added to employer-sponsored plans like 401(k)s, 403(b)s, and governmental 457(b)s. It is a separate account that accepts post-tax contributions. When an employee contributes, the amount is included in their gross income for the year, meaning no immediate tax deduction is received.
Employee contributions to a Designated Roth Account are part of the overall deferral limit, which is combined with any pre-tax contributions. For 2025, this combined limit is $23,500. Individuals age 50 or over can make additional “catch-up” contributions of $7,500, while those aged 60 through 63 can contribute a higher catch-up amount of $11,250.
Employer matching contributions are handled differently. Even when an employee directs their own contributions to a Designated Roth Account, any matching funds from the employer are deposited into a separate, traditional pre-tax account. This means the employer’s match will be taxable upon withdrawal in retirement.
Tax Treatment of Distributions
A qualified distribution from a Designated Roth Account is entirely free from federal income tax during retirement. This tax-free status applies to both the employee’s original contributions and all accumulated investment earnings. This is the benefit of having made contributions with post-tax dollars.
For a withdrawal to be a qualified distribution, two conditions must be met. The first is the five-year holding period, which requires that five years have passed since the first day of the calendar year of the employee’s first Roth contribution. The second condition is that the employee must be at least age 59½, be permanently disabled, or the distribution is made to a beneficiary after the employee’s death.
If a withdrawal does not meet both requirements, it is a non-qualified distribution. The portion of the distribution representing the employee’s original contributions is returned tax-free. However, the portion from investment earnings is included in gross income and taxed at ordinary rates. These earnings may also be subject to a 10% early withdrawal penalty if the individual is under age 59½.
Rollover Rules for Roth Balances
Specific rules govern the rollover of a Designated Roth Account balance when an employee leaves a job. A direct rollover, where funds are transferred from one financial institution to another, is a non-taxable event that maintains the tax-advantaged status of the funds.
An individual has two primary options for rolling over the balance from an employer’s Designated Roth Account. The first is to move the funds into a Designated Roth Account within a new employer’s plan, such as a Roth 401(k). The second option is to roll the balance into a Roth IRA.
An important detail is how the five-year holding period is treated during a rollover. If funds are rolled from one employer’s Designated Roth Account to another, the original five-year clock carries over to the new plan. This carryover rule does not apply when rolling funds into a Roth IRA, as the Roth IRA has its own separate five-year holding period.
In-Plan Roth Rollovers
Some retirement plans offer an in-plan Roth rollover, also known as an in-plan Roth conversion. This feature allows an employee to move existing funds from their traditional, pre-tax retirement account into their Designated Roth Account within the same plan. This process converts pre-tax retirement savings into post-tax Roth savings.
This transaction is a taxable event. The entire amount being rolled over from the pre-tax account, including contributions and earnings, must be included in the individual’s gross income for the tax year of the conversion. For example, converting $50,000 of pre-tax 401(k) funds to a Roth 401(k) adds $50,000 to that person’s taxable income for the year.
Individuals may consider this strategy if they believe their income tax rate will be higher in retirement than it is currently. By paying income tax on the funds now, all future qualified distributions from the converted amount, including subsequent earnings, will be tax-free. Plans may also allow vested amounts, such as matching and nonelective contributions, to be converted.