Fiscal Cliff Legislation Allows for In-Plan Roth Rollovers

did-you-knowThe American Taxpayer Relief Act of 2012, aka the Fiscal Cliff Legislation, contained a provision that allows retirement plan participants to convert their pre-tax funds in a 401(k), 403(b), or government 457 plan into an In-Plan Roth 401(k) account.

Prior to the legislation, participants could only roll over funds that were already eligible for distribution, i.e., if they were 59 ½ in age, had left the employer, were disabled, or met other eligibility requirements. Now they are able to convert within the 401(k) plan so long as their employer offers the Roth version and allows for conversions.

The government expanded the benefit to create a source of additional tax revenue. Legislators estimate that the rollovers will generate about $12 billion in additional federal income.

The upside for plan participants is that the rollover option offers a hedge against potential future tax rate increases. Plan participants who anticipate that rates will go up can, in effect, opt to pay taxes on their contributions now rather than later. While contributions to Roth 401(k)s are taxable, withdrawals are tax-free. With other defined contribution plans, savers put in pre-tax dollars and then pay taxes when they withdraw their funds.

While conversion may help plan participants, recordkeepers and plan sponsors must proceed with caution. The new law was written in general terms, without being vetted by industry professionals. It does not detail the recordkeepers’ responsibilities or address questions from a tax and plan administration perspective. Plan sponsors will have to evaluate the new tax treatment option to determine if this is an elective plan feature they wish to offer plan participants.

While IRS Notice 2010-84 addresses questions regarding In-Plan Roth rollovers for funds eligible for distribution, it is not clear whether this notice will apply to rollovers of ineligible funds.

The IRS said it anticipates issuing guidance later this year about the expanded in-plan Roth rollovers.

Please call your ABG representative if you have any questions about the latest regulatory and legal changes.