CPA & Business Advisory Blog

Qualified Retirement Plans Can Now Have In-Plan Roth Rollover Accounts

Many taxpayers, fearing an eventual increase in income tax rates, have taken the step of converting their individual retirement accounts to Roth IRAs, thereby paying taxes at current rates for the benefit of obtaining future tax free earnings.  A recent change in the law allows 401(k) plans to permit their participants to, in effect, re-characterize their 401(k) plan balances, within the plan, to Roth IRAs. 

What happens when a participant takes a distribution from a qualified plan? 

He or she will pay ordinary income tax on the distribution.  Additionally, unless the participant is over age 59-1/2 (or satisfies one of several other exemptions) at the time of distribution, a 10% excise tax will apply.  Any future earnings on the funds will be subject to taxation in the same way as any other investment.

Why might a participant want to take a distribution from a qualified plan? 

  • First, as stated above, if the participant feels that tax rates will rise, he/she might choose to pay tax today (at presumed lower rates) for complete tax exemption in the future. 
  • Secondly, if the participant makes this change to a Roth IRA account in 2010, he/she could elect to recognize the taxable income in equal installments in 2011 and 2012. 
  • Thirdly, plans can accomplish this transfer without a great deal of paperwork and without selling any investments—by making an election, the plan’s administrator would merely retitle the account as a Roth IRA-type account and prepare an IRS Form 1099-R—so this is much easier than requesting and receiving a distribution and then opening up a new account. 
  • Finally, the 10% excise tax referred to above will not apply to this transaction.

Is everyone able to do this?

The only participants who can use the in-plan Roth conversion are those who at the time of distribution, are over age 59 ½, have died, become disabled or are qualified to receive a qualified reservist distribution.  In 2010, this program is only allowed for 401(k) plans and 403(b) annuity plans; it will expand to 457(b) plans in 2011.

For a participant to be able to use this technique, the plan must have a qualified Roth contribution program in place.  Formal plan amendments are not required until the later of December 31, 2011 or the last day of the plan year where this would be effective—but the mechanisms for offering and administering this type of distribution must be in place.  Participants should talk with their plan administrators about the availability of this feature. 

For more information on retirement programs, post a comment below or contact our Compensation & Benefits Advisory Services Group at 440-449-6800.

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