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IRS Offers Tax Break on 401(k) Rollovers

WASHINGTON—The Internal Revenue Service has issued guidance making it clear that the 20% withholding tax that applies to certain pension distributions will not be imposed on 401(k) account balances that employees roll over to Roth 401(k) accounts.

“Mandatory 20% withholding does not apply to in-plan Roth direct rollovers,” the IRS said in a notice that was made available Tuesday.

The rollover feature was included in a small-business jobs bill that President Barack Obama signed into law followingcongressional passage in September.

If employers add the conversion feature this year, employees who roll over funds into a Roth 401(k) will get an extra tax break.

Under the law, employees who roll over funds from their regular 401(k) plan to a Roth 401(k) account by year end can pay taxes that are due on the money in equal parts in 2011 and 2012 rather than pay the entire tax liability next year.

But employers had been reluctant to add the feature until regulators resolved numerous questions, including whether the 20% withholding tax applied, that arose since thelegislation passed.

The IRS notice is at https://www.irs.gov/formspubs/article/0,,id=109875,00.html.