As of September 27, 2010, employees with 401k or 403b accounts can do a Roth conversion without taking money out of the plan — but only if the employer takes steps necessary to permit these conversions. Here are questions and answers about these provisions.
What does the new law allow?
Employer plans can now offer the opportunity to move 401k or 403b money from a regular (pre-tax) account to a designated Roth account (an after-tax account) within the plan. That means you don’t have to transfer money out of the plan to a Roth IRA to do a conversion.
Why do I care?
The ability to convert within an employer plan can be desirable if you aren’t in a position to take a distribution from the plan, or if you prefer not to do so, perhaps because you like the investment opportunities offered by the plan, or because you want to keep your money in a plan that’s covered by ERISA protections.
What happens if I do this?
The tax consequences are the same as if you did a conversion to a Roth IRA. You pay tax on the amount converted (reduced by any after-tax dollars included in that amount). If the conversion takes place in 2010, you can use the special delayed reporting rules for conversions this year. It’s a direct rollover, so there’s no withholding, and you’ll need to come up with money from a source outside your 401k account to pay the tax. If you follow all the rules for your designated Roth account, all distributions from the account will be tax-free, including all the investment earnings that accumulate after you do the conversion. You may want to note that the special five-year period in which you can incur a 10% early distribution penalty when withdrawing converted amounts will apply to these accounts just as they apply when converting to a Roth IRA.
When does the opportunity become available?
The law is effective for distributions after September 27, 2010. Congress intended to make the provision available for people who want to convert during 2010, qualifying for the special rules that allow delayed reporting of conversion income this year. (Some people may want to convert this year for another reason: the possibility of higher tax rates in 2011 and later years.) But you can’t do one of these conversions until your employer takes certain actions, and some employers may choose not to make the opportunity available.
What does the employer have to do?
First of all, the plan has to offer designated Roth accounts. What’s more, a committee report on the law says employers can’t offer these accounts solely to accept these conversions. The plan must offer the opportunity for workers to make regular contributions to designated Roth accounts, too.
What else?
Technically, the conversion is considered a distribution and rollover, so you have to be in a position where you’re allowed to take a distribution that’s eligible for a rollover. Many 401k plans don’t allow in-service distributions, that is, distributions for people who are still employed. However, the committee report says employers can amend the plan to allow in-service distributions solely for these conversions, making them available to workers who otherwise aren’t able to withdraw from their retirement accounts.
What else?
Employers are allowed to have a plan that offers designated Roth accounts without also offering these conversions, so they’ll have to amend their plans to add this feature. The committee report says they can begin offering the feature before the plan change is actually adopted, however, and add it later in a “remedial amendment.”
Tags: Roth conversion
My employer has denied my request to add this to our 401k. They say that it would require them to allow active participants to withdraw money from the plan.
Fidelity says that in order to support the Roth conversion, our plan would need to support one or both of the following “in-service” withdrawl types. These would also allow active participants to take $ out of the plan. Our plan is not able to add it with the limitation that only in-plan conversions are permitted.
1) In-service 24 month w/d– this type allows participants to w/d or convert to roth any employer money that’s >24 months old. Most plans do not offer this type of w/d because they don’t want active participants taking out match money.
2) In-service 60 month w/d– if participants have >60 months participation/eligibility they have access to the employer money. This would allow for a distribution…ie in-plan conversion or take a distribution (see 24 month w/d).
Kaye, does this seem right? I guess I trust Fidelity to know what they are doing, but, it seems like the rules make it impossible to allow in plan 401k -> R401k. I’m running out of steam here.
Thanks, -J
The Joint Committee on Taxation’s technical explanation of this legislation includes this statement: “[I]f an employer decides to expand its distribution options beyond those currently allowed under its plan, such as by adding in-service distributions or distributions prior to normal retirement age, in order to allow employees to make the rollover contributions permitted under this provision, the plan may condition eligibility for such a new distribution option on an employee’s election to have the distribution directly rolled over to the designated Roth program within that plan.” Once in a while something stated in one of these reports ends up not being an accurate statement about the law, but generally they correctly reflect congressional intent. Therefore it should be possible for an employer to allow these conversions without allowing actual distributions.
Note, however, that subsequent to my posting of this entry an IRS official warned employers against making these conversions available before the IRS publishes some guidance on how it works, so everyone should put this on hold for now.