Press Room: Tax Release

January 08, 2013

New Opportunity To Convert 401(k) Account to Roth Account

Starting in 2013, individuals who participate in an employer-sponsored 401(k) plan (including a solo 401(k) plan) or 403(b) plan may have the opportunity to convert any portion of their funds in those accounts to Roth accounts under the plan (an "in-plan Roth conversion"). This new tax provision was included in the American Taxpayer Relief Act of 2012, which was recently signed into law by President Obama. Prior to 2012, only participants who were eligible for a distribution under the plan could make such conversions. The benefit of the in-plan Roth conversion is that the earnings of the account after the conversion may not be subject to federal income taxes and the minimum distribution rules would not apply to amounts that are ultimately rolled over to a Roth Individual Retirement Account (IRA).

For individuals to make an in-plan Roth conversion, it is necessary that the employer-sponsored plan offers a designated Roth account and also permits the conversion. Employer-sponsored plans are not required by law to offer a designated Roth account or the conversion feature. Therefore, it is important for participants who are interested in doing an in-plan Roth conversion to determine from their employer the terms of the plan.

An in-plan Roth conversion results in the individual recognizing taxable ordinary income equal to the amount converted, but the 10% early-distribution penalty does not apply. The income taxes due as a result of the conversion have to be funded through assets held outside of the employer-sponsored plan.

There are a couple of rules to remember when considering an in-plan Roth conversion. The tax-free distribution of the earnings is only available if the designated Roth account has been in existence for at least five years and the distribution is made after the individual has attained age 59 ½. Unlike Roth IRAs, minimum distributions are required once the individual attains age 70 ½. However, the amounts in a designated Roth account can be rolled over to a Roth IRA. Finally, a Roth conversion in an employer-sponsored plan cannot be undone – the election is irrevocable. This is in stark contrast to IRA conversions to a Roth IRA, which may be undone by the due date, including extensions, for filing the individual’s income tax return for the year of the IRA conversion.

Whether an in-plan Roth conversion would be advantageous depends on many factors, including current and future tax rates.