A 401(k) in-plan Roth conversion (also called an "in-plan Roth rollover") allows employees to transfer the vested non-Roth portion of their 401(k) plan accounts (for example, employee pre-tax and after-tax contributions, company contributions, and any investment earnings) into a designated Roth account within the same plan.
Employees have to pay federal income tax now on the amount they convert (reduced by any basis the employee has in the converted funds), but qualified distributions from their Roth accounts in the future will be entirely income tax free. Also, the 10% early distribution penalty generally doesn't apply to amounts converted (but that tax may be reclaimed by the IRS if an employee receives a nonqualified distribution from his or her Roth account within five years of the conversion).
While in-plan conversions have been around since 2010, they haven't been widely used, because they were available only if employees were otherwise entitled to a distribution from the plan — for example, upon terminating employment, turning 59½, becoming disabled, or in other limited circumstances.
The American Taxpayer Relief Act of 2012 eliminated the requirement that employees be eligible for a distribution from the plan in order to make an in-plan conversion. If the plan permits, employees can now convert any vested part of a traditional 401(k) plan account into a designated Roth account regardless of whether they are otherwise eligible for a plan distribution. The law also applies to 403(b) and 457(b) plans that allow Roth contributions.
Here are some additional points about in-plan Roth rollovers to consider:
- If an amount rolled over into a designated Roth account was subject to distribution restrictions prior to the rollover, then that amount will continue to be subject to the same distribution restrictions after the rollover.
- If an in-plan rollover is the employee's first Roth contribution to the plan, then the five-year period for determining qualified distributions begins on January 1 of the year in which the employee makes the in-plan rollover.
- Amounts that are otherwise non-distributable may be rolled over into a designated Roth account only via a direct rollover. Amounts that are otherwise distributable from the plan may be rolled over using either a direct rollover or an indirect (60-day) rollover (however, a 60-day rollover will be subject to 20% withholding).
- Your plan is not required to allow in-plan Roth rollovers. You may also limit the types of dollars that may be rolled over and the frequency of rollovers.
- If your plan allows, an in-plan Roth direct rollover can include an employee's outstanding plan loan, if there is no change in the loan's repayment schedule. The taxable amount is generally the balance of the loan at the time of the rollover.
Is a Roth conversion right for you?
Whether a Roth conversion makes sense financially depends on a number of factors, including an employee's current and anticipated future tax rates, the availability of funds with which to pay the current tax bill, and when he or she plans to begin receiving distributions from the plan. Also, employees should consider that the additional income from a conversion may impact tax credits, deductions, and phaseouts; marginal tax rates; alternative minimum tax liability; and eligibility for college financial aid. Employees should consult a qualified professional before making a conversion.
Prepared by Broadridge Advisor Solutions Copyright 2023.
