In-Plan Roth 401(k) Conversions Part 1

This entry is the first of a two-part series covering in-plan conversions to the increasingly popular Roth option.

A January 2013 survey by Aon Hewitt found that an increasing number of US employers plan to add a Roth option to their retirement plans over the next 12 months. The survey results come shortly after a provision in the American Taxpayer Relief Act (the “fiscal cliff” tax act adopted in January) gave workers a chance to stockpile more tax-free earnings — as long as their employers’ 401(k) plans include a Roth option, along with the ability to move assets accumulated in tax-deferred 401(k) accounts.

Under traditional 401(k) plans, employees make pretax contributions and pay income taxes on all distributions after retirement. Roth 401(k) contributions, by contrast, are made with after-tax dollars, and funds in the plan grow tax free. Upon retirement, no taxes are owed on any distributions. The Roth conversion option also applies to other retirement savings plans, such as 403(b), 457(b) and thrift savings plans.

Previously, converting funds from a pretax to a Roth 401(k) account was limited to money already “distributable” without penalty from the pretax plan — typically, the vested balance when an employee reached age 59½ or terminated employment, unless the plan otherwise allowed in-service distributions. Under the new rules, an employee of any age or employment status can convert everything in a traditional 401(k), including pretax salary deferrals, into a Roth 401(k).

The intent of these rules is that savers will flock to this new opportunity, resulting in a lot of new near-term tax revenue for the government because taxes are payable on conversion.

The Aon Hewitt survey also found that:

  • 49% of the respondents don't currently offer a Roth option.
  • 29% of those are very or somewhat likely to add this feature in the next year.
  • 76% of those new adopters will add both the Roth contribution and in-plan conversion features.
  • 52% of the employers who already have a Roth contribution option but don’t offer in-plan conversions are very or somewhat likely to do so in the next 12 months.

Industry groups representing recordkeepers and other service providers are pressing the Treasury Department for additional guidance about the new rules.

In the second part, we'll consider who might want to take advantage of the in-plan Roth 401(k) conversion opportunity.

Any opinions expressed are solely the opinions of Jon Vogler and do not necessarily reflect the opinions of Invesco Distributors, Inc. or any of its affiliates. This information is not intended as tax advice. Please consult a tax advisor regarding individual situations.

Invesco Distributors, Inc.

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