By Patrick J. Gallagher, CEBS
Carroll Consultants, Ltd.
President Obama signed the American Taxpayer Relief Act of 2012 in an effort to avoid the “fiscal cliff” on January 2, 2013. One of the law’s provisions adds the ability to offer In-Plan Roth Transfers in a 401(k), 403(b) or 457(b) plan. This new provision is optional and not required to be offered under your plan.
What is an In-Plan Roth Transfer?
An in-Plan Roth Transfer is the conversion of an amount from a non-Roth account in a 401(k), 403(b) or 457(b) plan to a Roth account in the same plan. All vested amounts under the plan, including deferral contributions, employer matching contributions and employer non-elective contributions are eligible to be converted. This includes any earnings accrued under these accounts as well. All in-Plan Roth Transfer is irrevocable once made.
What Plans are Eligible to allow an In-Plan Roth Transfer?
All 401(k), 403(b) and 457(b) retirement plans that provide for designated Roth contributions can allow In-Plan Roth Transfers. The plan will need to be amended to allow for this type of transfer. Since the provision is a discretionary amendment to the plan, the Employer has until the end of the plan year to adopt the amendment. The plan may permit participants to make the transfer election prior to the adoption of the amendment as long as the Employer adopts the amendment by the end of the plan year in which the first conversion is made.
Who is Eligible to make an In-Plan Roth Transfer?
All participants with an account balance under the plan, including former participants, beneficiaries, and alternate payees.
What are the Tax Consequences of the Amount Converted?
All taxable portions of the amount converted are subject to federal and state income tax as if actually distributed from the plan, and will be reported on Form 1099-R in the year converted. Amounts converted are taxable at current income tax rates. Earnings on the account from that point on are completely tax-free if it is paid as part of a “qualified distribution.” A distribution is qualified only if it occurs at least 5 years after the participant’s first designated Roth contribution and it is made on account of the participant’s disability, or made after death or attainment of age 59 ½. If the distribution is not a qualified distribution, then the accumulated earnings will be subject to tax, and additional taxes may apply.
In-Plan Roth Transfer Advantages
Earnings credited after the conversion are distributed tax-free
Attractive for those individuals in lower tax brackets who have assets outside of the plan that can be used to pay taxes on the conversion.
Expectation to be in a higher tax bracket at retirement than currently
In-Plan Roth Transfer Disadvantages
Participant must pay tax on the amount converted in current year
Related lost opportunity cost of current tax dollars paid
Possibility that IRS may change the tax treatment of Roth 403(b) distributions in the future
If you have any questions or would like to know more about this topic, please contact Pat Gallagher at 610-225-1217 or firstname.lastname@example.org.