Thin(k) About Your 401(k) Plan: In-Plan Roth Conversion
The Small Business Jobs Act of 2010 modified by The American Taxpayer Relief Act of 2012 gave retirement plan sponsors the ability to offer in-plan Roth conversions. Additionally, plans that don’t currently offer the provision can add the option. An in-plan Roth conversion is a way to convert pre-tax savings to Roth savings.
Participants opting to do so must report the conversion amount as gross income on their tax return in the year of conversion and pay taxes due as a result. The Roth money then grows tax deferred and can be distributed tax free as long as the participant leaves the converted money in the Roth account for five years and has reached the age of 59 ½. This is a complex tax issue and anyone considering an in-plan Roth conversion should consult with their tax advisor.
Some of the reasons to consider an in-Plan Roth conversion are:
- Expectation that tax rates will be the same or higher in the future
- Taxes due can be paid from a source other than the retirement account
- Desire to have a bucket of cash available tax free in retirement
- Investing for the long-term, especially five-plus years to avoid penalty and taxes
If you expect your taxes to be lower in retirement, you don’t have cash available to pay taxes due at conversion or you will need access to the money in less than five years, this option may not be for you.
There are a few things to consider before you explore an in-plan Roth conversion. First, does your plan offer the option or intend to in the future? No need to consult your tax advisor if the answer is no. Second, make sure you fully understand the requirements for the money to be distributed tax free (five-year holding period and age 59 ½) or you may subject yourself to a 10% penalty tax and taxes due for early withdrawal.
However, given the current chatter about higher taxes in the future, more and more savers are interested in exploring the in-plan Roth conversion option. Vanguard provides a helpful table here, that explains in further detail the option. ThirtyNorth Investments does not give tax advise. You should consult your tax professional regarding in-plan Roth conversions.
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