New Guidance on In-Plan Roth Conversions

November 27, 2010

The IRS has released a 12-page notice (PDF) providing guidance in question-and-answer form for employers that want to offer their 401k or 403b participants the opportunity to move money from a regular account to a designated Roth account within the same plan. This guidance was on a fast track so that employers could make this opportunity available before the end of 2010 for those participants who want to take advantage of the special rule, available only this year, to delay the reporting of income from a conversion — splitting it between 2011 and 2012 instead of reporting it as 2010 income.

The notice provides needed clarifications but no suprises. Here are some of the key points:

  • Plan amendment. An employer doesn’t have to adopt a formal plan amendment before implementing this option. The notice provides an extension of time in which the required amendment can be adopted retroactively.
  • Roth contribution program required. Employers can’t offer the in-plan conversion option unless they also allow plan participants to put their regular 401k or 403b contributions into a designated Roth account.
  • Amounts eligible for distribution and rollover. In-plan Roth conversions are available only for amounts that are eligible for distribution and qualify for rollover treatment. However, an employer that does not otherwise permit in-service withdrawals can permit them (for eligible participants) solely for the purpose of in-plan Roth conversions.
  • Withholding not required. Withholding doesn’t apply to a direct in-plan Roth conversion.
  • Recharacterizations not permitted. There’s one serious drawback to an in-plan Roth conversion compared with other types: you can’t use a recharacterization to undo the conversion if you change your mind later.
  • Plan loans are not a problem. A plan participant who has taken a loan from her account can do an in-plan conversion that moves that loan from the regular account to the Roth account, with the unpaid balance of the loan being treated as the amount transferred.
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