In-Plan Roth Conversions

The newly signed American Taxpayer Relief Act of 2012 (the “Act”) makes an important change to employer-sponsored retirement plans. The Act amends the tax code to expand the availability of in-plan Roth conversions. Although participants have been allowed since 2010 to convert amounts in the plan that are currently eligible for distribution, the new provision will allow participants to convert any vested pre-tax amounts inside the plan to a designated Roth account maintained in the plan, regardless of whether the amount transferred is otherwise eligible for distribution. This expanded conversion provision is optional and is effective immediately. Such a transfer will result in taxable income to the participant in the year of the conversion. Participants who take advantage of this option would need to have money available outside of the plan to pay the applicable taxes, assuming that they are not eligible for a distribution from the plan to cover the tax liability.

The provision only applies to plans that permit Roth deferrals. Any participant may take advantage of the conversion option, regardless of income or account balance. Any such conversion would be irrevocable, unlike a Roth IRA conversion which can sometimes be reversed.

One complexity of the new provision is that it is believed that any withdrawal restrictions that existed prior to conversion should continue to apply to the money after the conversion. This requirement may create the need to establish Roth sub-accounts if there are different withdrawal restrictions on the various money types in the plan. For example, if a participant converts his profit sharing account and his 401(k) account to a designated Roth account and those accounts had different withdrawal options prior to the conversion, then those same withdrawal options will likely need to be applied to the newly created Roth balances that will exist after the conversion, thus creating the need for two Roth sub-accounts.

The Act does not specifically address the process required to amend the plan to allow for conversions. However, it is assumed that such a change would be considered a discretionary amendment which the employer will need to sign before the end of the plan year in which it is first effective. In addition, there is no guidance yet on 1099-R reporting for such a conversion, but presumably the converted amount would be reported in Box 1 as a gross distribution, with no federal income tax withholding reported in Box 4. Participants will be subject to ordinary income tax on the conversion amount, but not subject to the 10% early distribution penalty. No spousal consent will be required for the conversion, even if the plan otherwise requires spousal consent on distributions.

We anticipate additional guidance from the Internal Revenue Service on this issue and will provide further details as they are available. If you have any questions about adding this optional provision to your plan, you should contact your Account Executive.

author

Annemarie Keehn has worked for over 29 years in the field of Defined Contribution Plan Administration. She graduated from Indiana University with a Bachelor of Science in Business Management. Anne joined RMS as an Account Executive in 2007. Her areas of expertise include qualified retirement plan administration and consulting, plan document underwriting, and compliance. She focuses the majority of her time at RMS on new client implementation and onboarding as well as assisting with marketing and new business initiatives.  She also maintains the plan document used by the firm and performs special research projects.  Anne has been awarded the designations of Qualified 401(k) Administrator and Qualified Pension Administrator from the American Society of Pension Professionals & Actuaries and has been approved by the Internal Revenue Service as an Enrolled Retirement Plan Agent. She is a member of the Louisville Employee Benefits Council.

  

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