Retirement Plan Roth Conversions

You may already know that individuals with regular IRA accounts (pre-tax) have the option to convert all or a portion of the pre-tax IRA account to a Roth Account. The benefit of the Roth Account is that, since taxes are paid upon the conversion, taxes are not due at the time of distribution. This means that for qualifying distributions, a participant could receive the distribution tax free. What may be new information is that this same provision is now allowed in 401(k) plans.

If your current 401(k) plan allows Roth Deferrals, and the plan document allows for ‘In Service’ distributions or ‘In Plan’ Roth Conversions, you may want to look into the possibility of converting all or a portion of your pre-tax money to Roth.

After you have paid taxes on the conversion amount, you will not owe taxes on the converted account balance or the growth on the account for a qualifying distribution.  As you move toward retirement—and your account grows—the increase in the account is also tax free when distributed.

Although it sounds like a great opportunity, there are issues to consider before making the conversion decision.

  • Does your current 401(k) plan allow for Roth 401(k) Deferrals?
  • Does the plan allow for ‘In Service’ distributions?  This means that you can take money out of the plan while still employed.  Many plans do not have that provision.
  • Does the Plan allow for ‘In Plan’ Roth Conversions?  This means the plan allows participants to convert pre-tax money to Roth money, but the assets cannot leave the plan.  This is a very new feature that is being added to some plans, but not many.
  • Moneta believes that when a conversion takes place, taxes owed on the conversion should be paid with funds other than those being converted.  Is there money outside the conversion assets to pay any taxes due?
  • It is appropriate to consult a tax advisor to determine the tax consequences of this action.
  • Not all balances are available to be converted at any time.  Specific rules exist that address the amounts that are available and the timing of availability for conversion.

One important point to note is that taxes are due on the conversion for the tax year in which the conversion takes place.  For example, if you convert in 2011, you must include the conversion on your 2011 taxes and you will owe taxes on the conversion amount for the 2011 tax year.

The rules are complex and still new.  Many 401(k) plans will not have these rules in place yet.  If you have an interest in converting all or a portion of your pre-tax account balances to Roth, you should first consult your tax advisor to determine if it makes sense to do the conversion.  Second, you will need to speak to the representative at your company who handles the 401(k) plan to determine if the plan allows for Roth Deferrals and, if so, determine whether or not the plan allows for ‘In Service’ Distributions or ‘In Plan’ Roth Conversions.

For many individuals, the conversion process makes sense, but everyone’s situation is different and must take into account specific tax situations, goals and the needs of the individual. However, If you are able to answer ‘yes’ to the questions posed above, you may want to look into whether a conversion makes sense for you.

Sean Duggan, CPC, QPA, QKA

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