As part of the fiscal cliff deal employees have been given the ability to take funds in a pre-tax 401(k) account and convert it into a Roth 401(k) account. Prior to this most recent provision in the American Taxpayer Relief Act of 2012, only amounts that were deemed distributable could be converted to Roth Accounts. Under the new provision, participants don’t need to wait until an attainment age of 59 ½ to be able to make the conversion to a Roth account. While the effective date is January 1, 2013, prior account balances including all pre-tax 401(k) contributions to date, earnings on those funds, as well as any employer match, are all permitted to be converted.
Who should take advantage of this provision?
• If you expect your tax rate to be the same or higher in retirement and you won’t need the funds for ten or more years.
• For employees with large pre-tax balances, they can convert part of the 401(k) at a time. The longer the money has to grow, the more likely that the conversion will be worthwhile.
• Younger workers that have the cash on hand to pay the conversion tax.
What are the benefits?
• Tax savings
• The ability to leave an income-tax-free inheritance to kids or grandkids
• Access to lower institutional class funds
• Better creditor protection (because it is governed by ERISA)
If employers don’t already offer Roth accounts, they will need to amend their plans to allow for them, and then they will need to amend their plans again to allow for the in-plan conversions.
