In-Plan ROTH conversions

As a result of the dreaded fiscal cliff negotiations, on January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012.  One of the provisions of this bill was to expand in-plan Roth conversions.  These new provisions may appeal to individuals who expect their tax rates to increase or to wealthy individuals who want to leave their retirement accounts to heirs. 

In-plan Roth conversions were first introduced in 2010.  At the time the Small Business Jobs and Credit Act was passed to allow plan sponsors to permit 401(k), 403(b), or 457 plan participants to convert employee pre-tax accounts to Roth accounts.  However, this conversion feature was limited to amounts that were currently eligible for distribution from the plan.  Generally, this limited most active participants to only being able to do an in-plan Roth conversion if they were eligible to take a 59 ½ in-service distribution.

The American Taxpayer Relief Act greatly expands a participant’s ability to do an in-plan Roth conversion.  Instead of being limited to amounts that would be otherwise eligible for a distribution, the new legislation allows for in-plan Roth conversion of any employee contribution accounts.  Under the law any Roth conversions will be taxed in the year of the conversion.  This is a change from the prior legislation which allowed taxes from a Roth conversion to be paid over a two year period.

It is important to note that in order for a plan sponsor to allow in-plan Roth conversions their plan document must allow for Roth contributions and must be formally amended to permit in-plan Roth conversions.

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