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New Guidance Issued on 401(k) Roth Conversions
 

By Stephen Miller, CEBS  12/19/2013
 

The Internal Revenue Service, in Notice 2013-74, is providing guidance on a change in law that permits sponsors of 401(k) and other defined contribution retirement plans to allow in-plan Roth conversions, meaning participants may roll over pretax funds from a traditional 401(k) to a Roth 401(k) by paying income taxes on the converted amount.

Plan sponsors have the option, but not the obligation, to amend their eligible plans to add or expand the in-plan Roth-conversion feature, the agency explained in the notice, issued Dec. 11, 2013.

Funds in a Roth 401(k), Roth 403(b) or similar plans are not subject to taxes when withdrawn during retirement. “The continued upswing of Roth usage is interesting because the usage is driven by younger investors,” Laurie Nordquist, director of Wells Fargo Retirement, told SHRM Online earlier this year. “This suggests that they are aware that their tax rates will likely go up as they age, and, therefore, it is a good strategy to opt for the lower tax bracket now versus waiting to be taxed at their unknown rates in their 60s.”

The new guidance clarifies Roth-conversion options enacted early in 2013 as part of the American Taxpayer Relief Act, which expanded a limited in-plan Roth-conversion option to all vested amounts under eligible plans, including those amounts not yet eligible for distribution.

"By broadening the pool of eligible assets, the new in-plan Roth conversion rule provides participants with a much greater opportunity to convert pretax dollars to Roth after-tax dollars. This is especially attractive for those individuals currently in lower tax brackets who have assets outside of the plan that can be used to pay taxes on the conversion," observed an alert from law firm Morgan Lewis.

Notice 2013-74 confirms that plan sponsors that implement an in-plan Roth-conversion option generally may do the following:

  • Limit the types of vested pretax contributions that participants can convert.

  • Specify the frequency with which participants can elect to make in-plan conversions.

  • Discontinue such in-plan conversion programs.

In addition, the guidance explains that the “not otherwise distributable” amounts that may be rolled over into a Roth account include the following types of contributions (and any earnings that follow):

  • Elective deferrals in 401(k) and 403(b) plans.

  • Matching contributions and non-elective contributions.

  • Annual deferrals made to governmental 457(b) plans.


Increased Withholding Advised
 

The taxable amount of an in-plan Roth conversion must be included in a participant’s income. "A participant making an in-plan Roth rollover will need to make all arrangements for tax payments outside the plan," states an alert from Buck Consultants.

Although any such rolled-over amount is not subject to withholding, "a participant making an in-plan Roth rollover may need to increase his or her withholding or make estimated tax payments to avoid an underpayment penalty," adds an advisory from law firm Bryan Cave.

"For plan sponsors of safe harbor 401(k) plans, the new guidance provides a temporary period (ending Dec. 31, 2014) during which a mid-year change to provide for such rollovers is permitted," Bryan Cave noted. "This is good news for 401(k) plan sponsors who have either not previously amended their plan documents for in-plan Roth distributions or desire to amend their plan documents in light of this new guidance."

Stephen Miller, CEBS, is an online editor/manager for SHRM. 


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