January 27, 2014

Guidance from IRS May Make In-plan Roth Conversions Easier

While the 2012 American Taxpayer Relief Act made it possible for plans to allow participants to convert all vested pre-tax amounts to a Roth account, many plan sponsors were tentative about changing plan rules to allow these conversions. New guidance from the Internal Revenue Service offers clarifications for 401(k), 403(b), and governmental 457 plans that may make Roth conversions more accessible.

Released on December 11, 2013, IRS Notice 2013-74 makes it clear that participants can convert any vested amount, including amounts not otherwise distributable, to a Roth account if the plan permits it. This includes pre-tax elective deferrals, employer matching contributions, and non-elective employer contributions, at the discretion of the plan sponsor, who has the ability to restrict the types of rollover-eligible contributions and the frequency with which rollovers are permitted.

Converted amounts continue to be subject to the same distribution restrictions that applied prior to the conversion. For example, if a participant who is younger than age 59 ½ and still employed rolls over pre-tax savings to a Roth account, that rollover amount may not be distributed from the plan until the participant reaches age 59 ½ or another distribution event occurs.

However, Roth conversions still require that income taxes are paid! When non-distributable assets are rolled into a Roth, they are not subject to withholding, which means that participants who are converting non-distributable assets to a Roth will be required to pay income taxes from sources outside of the plan.

Contact your advisor for additional information on this IRS guidance or any other investment-related question.

Read the full IRS Notice 2013-74 here: http://www.irs.gov/pub/irs-drop/n-13-74.pdf/.