Senate Would Expand Roth Accounts

June 30, 2010

Action in the Senate June 29 may result in expanded access to Roth accounts. One provision would take effect upon enactment, which is on a fast track. Before it can become law, the provision must be approved by the House of Representatives.

The legislation would expand Roth accounts in two ways. One would authorize Roth accounts in governmental 457b plans beginning in 2011. These plans offered by state and local governments are similar to 401k and 403b plans offered by businesses and educational or charitable organizations. A previous law specified that Roth accounts would be available in the federal Thrift Savings Plan beginning in 2011, so this change would make it possible for state and local governments to offer the same benefit to their employees.

The legislation would also make it possible for participants in 401k, 403b and governmental 457b plans to move money from a traditional account within the plan to a Roth account — in other words, to do a Roth conversion within the plan. This provision would take effect immediately upon enactment, which could occur within a few weeks. Individuals taking advantage of this provision in 2010 would be allowed to report the income on a delayed basis (half in 2011 and half in 2012), the same as if they were converting to a Roth IRA.

The opportunity would not be immediately available to all plan participants, however. Employers are not required to offer designated Roth accounts in their retirement plans. You can’t use this strategy unless you participate in a retirement plan that offers these accounts.

What’s more, the conversion opportunity applies when a distribution from a traditional account in the plan is rolled over to a designated Roth account within the plan. In many plans, participants are not allowed to take distributions until termination of employment. If you participate in such a plan, the Roth conversion opportunity will not become available until the plan is amended to permit current employees to take distributions for this purpose.

These provisions are included in the new (June 29) Senate version of the small business tax legislation. The House version of this legislation relied primarily on a new restriction on an estate planning device (grantor retained annuity trusts, or GRATs) to replace the revenue lost as a result of various tax breaks being provided to small businesses. The Senate amendment replaces the restriction on GRATs with the new rules for Roth accounts, which have a similar effect on the federal budget.

The House previously passed its version of the legislation. It appears that the Senate will pass its version of the legislation quickly. After that, the House may vote on the Senate version or request a conference to negotiate a compromise between the differing versions.

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