The Small Business Jobs Bill, which was recently signed into law by President Obama, includes a provision that will add some additional planning opportunities for participants of 401(k) plans with Roth provisions. Roth IRA accounts are after-tax monies that grow tax-free. Distributions from the accounts can be made without any tax consequence. This provides additional flexibility to taxpayers when planning for retirement or death transfers. One of the main estate planning benefits of Roth IRA accounts is that the minimum required distribution provisions do not apply to them.
How the New In-Plan Roth Conversion Works
Under the new law, if a Section 401(k) or 403(b) plan already includes a Roth contribution provision, a participant with a non-Roth account, that is distributable as an eligible rollover distribution, will be permitted to roll over the account into a designated Roth account within the plan. This is an optional plan provision. Amounts become distributable as an eligible rollover distribution following the occurrence of one of several statutorily defined events, which typically require severance of the employment relationship. The new law still does not allow participants to convert their non-Roth amounts unless they have a distributable event.
Planning Opportunity is Limited
Since conversion of non-Roth accounts, even within a plan, will still not be able to occur without a distributable event, the actual usage of this new provision remains to be seen. Most participants experiencing a distributable event will still opt to move their accounts to an IRA or another qualified plan anyway, and most plan sponsors encourage participants to take their accounts with them when they leave employment to ease administrative burdens. In addition, Roth IRA accounts have the additional benefit of no minimum required distributions at age 70 1/2. Minimum required distribution provisions applicable to 401(k) plans still apply to the Roth accounts within these plans, regardless of how they were established – via salary deferral contributions or rollover from traditional tax deferred accounts.
What Types of Accounts Can Be Converted?
It does appear that all vested amounts available to the participant as an eligible rollover distribution can be converted to Roth amounts within the plan (for example, pre-tax deferral, after tax employee contribution and certain vested employer contribution amounts). Unfortunately, if the plan does not have a Roth provision, the new in-plan Roth rollover provisions are not permitted. Adding a Roth account provision to a qualified 401(k) plan requires a plan amendment. Plan sponsors will be able to adopt the conversion option in 2010.
What is the Tax Impact of an In-plan Conversion?
Any taxable amounts that are converted to Roth amounts as part of the in-plan conversion will be taxable to the participant in the year in which the conversion takes place. There is a special rule for 2010 conversions allowing taxpayers to defer and spread the tax liability ratably over two years starting in 2011. Once a conversion election is made for 2010, it may not be revoked after the due date of the participant’s tax return.
To learn more about how you may be able to take advantage of the new Roth provisions, talk to your accounting professional.