Employee Benefit Plans: The 411

Valuable Information on 401ks, Pensions, ESOPs, Form 5500 Preparation + More

Exploring Roth In-Plan Conversions

Brief History

The Economic Growth and Tax Relief Reconciliation Act of 2001 authorized the establishment of Roth 401(k) accounts beginning January 1, 2006, which are post-tax retirement account. The next big thing to happen to Roth accounts was the American Taxpayer Relief Act of 2012, which opened the doors to in-plan Roth conversions. Effective immediately as of December 31, 2012, this act expanded Internal Revenue Code section 402A to allow vested amounts that are not otherwise distributable, meaning 401(k) deferrals, vested employer matching deferrals, etc., to be transferred to a designated Roth account maintained within a plan.

As an optional provision, Plan sponsors have the choice to add this provision to their plan document and allow participants to convert traditional 401(k) amounts in their accounts to Roth accounts. However, the Plan must already allow for Roth elective deferrals, and if it does not, that must be added to the plan document as well.

Brief Rules and FAQ

What plans are covered?

  • Any 401(k), 403(b), or governmental 457(b) plan that has been amended to permit Roth elective deferrals.

Which participants are eligible

  • Any participant, including an active or former participant, with an account balance in the plan.

Amounts eligible for conversion?

  • Typically the following amounts are eligible for conversion:
  • Pre-tax 401(k), 403(b) deferrals, & 457(b) deferrals, and earnings thereon
  • Vested matching contributions and earnings thereon
  • Vested profit sharing contributions and earnings thereon

When is the deadline for conversion?

  • December 31 of each year. The conversion amount will be considered taxable income for that year.

Consider exploring if:

  • You are in a low tax bracket this tax year.
  • You have plenty of time until retirement age.
  • Generally, the younger you are, the more you benefit.
  • You have available resources to pay the tax created by the conversion.
  • You are expecting to receive a tax refund.
  • Use the refund to pay the tax on conversion.
  • Example: Assume you are in the 25% tax bracket, and want to use $500 of your tax refund to pay for conversion tax; you could convert up to $2,000 ($500/25%).
  • You are interested in an estate planning tool by the use of Roth savings.
  • Roth accounts pass income tax free to your heirs.

Note: The purpose of providing this information is to inform participants in 401(k) plans that this option exists for them. I would advise anyone considering an in-plan Roth conversion to consult with a financial adviser to weigh the pros and cons of this decision and align this decision with future financial goals.

By Josh Mitchell, CPA