Roth 401(k) conversions: Tips for plan sponsors and participants
Posted On: 9-12-2014 | Posted By: WK Staff
Roth 401(k) accounts, which have been available since 2010 but not widely until this year, can offer several opportunities for tax savings and estate planning in the right circumstances.
Unlike pre-tax retirement accounts that are included in taxable income when distributed, after-tax Roth contributions and earnings are distributed tax-free, providing certain conditions are met.
Since 2010, retirement plans have had the option of allowing participants to convert pre-tax accounts to after-tax Roth accounts through an in-plan Roth rollover. However, application was limited, for the most part, to participants over the age of 59 ½. Then came the American Taxpayer Relief Act of 2012, which expanded the availability of in-plan Roth conversion to include account balances of participants under age 59 ½. As a practical matter, though, the option was not available to most plans until additional guidance was issued by IRS in late 2013, allowing retirement plan sponsors to first offer the option in 2014.
If you are a retirement plan sponsor considering allowing Roth conversion in your retirement plan, or a 401(k) participant considering converting some or all of your current pre-tax account to after-tax Roth, you might want to first discuss the implications with your WK advisor. Below is a brief summary of issues plan sponsors and participants should consider.
- Your plan document must be amended to add a Roth conversion option. The deadline to amend is December 31, 2014, if you want to provide the Roth conversion option in 2014.
- Your plan document must allow Roth salary deferral contributions in order to allow Roth conversions. If your plan does not currently allow Roth deferrals, you should amend your plan to include language adding the Roth contribution feature.
- You will need to work with your 401(k) vendor regarding the operational requirements for Roth conversions. If you are adding Roth contributions for the first time, you will also need to work with your payroll and 401(k) vendors to accommodate Roth salary deferrals.
- You will need to notify plan participants of the new features. Your third-party administrator will typically assist you with the required notices.
- Your 401(k) provider will not withhold taxes on an in-plan Roth conversion. Therefore, you may need to increase federal and state tax withholding via payroll or make estimated tax payments to avoid an underpayment penalty. You should consult with your WK advisor regarding this issue prior to initiating an in-plan Roth conversion.
- After an in-plan Roth conversion is processed, it cannot be undone.
- In-plan Roth conversions are reported as taxable income in the year processed on Tax Form 1099-R, which is due to the participant no later than the Janaury 31 following the year of the conversion.
If you would like to discuss in-plan Roth conversion or any retirement plan matter in more detail, please contact your WK tax or employee benefits advisor at (573) 442-6171 or (573) 635-6196.