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  • Home>Practice Management>Retiring With Natalie Choate>New! In-Plan Roth Conversions

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    New! In-Plan Roth Conversions

    The Small Business Jobs Act of 2010 is the answer to this client's prayers.

    Natalie Choate, 10/08/2010

    Do you have your own solutions/suggestions? Leave a comment at the end of the article!

    Natalie Choate will be speaking at a location near you if you live in Grand Rapids, Mich., or Detroit (Oct. 26-27 and Oct. 29), South Bend, Ind. (Oct. 28), Waltham, Mass. (Nov. 4), St. Charles, Ill. (Nov. 17), Orlando, Fla. (Jan. 11), Kansas City (Feb. 23), Houston (March 22), and Jacksonville, Fla. (May 10). See all of Natalie's upcoming speaking events at www.ataxplan.com.

    Question: I am a retired director of a professional corporation, age 68. I have a substantial balance still in the corporation's 401(k) plan. I want to convert that balance to Roth status in 2010, to take advantage of the 35% top income tax rate while it lasts. However, I prefer to keep my money in the company's plan for a couple of reasons. First, I have professional investment options available to me through the company plan that I would no longer be able to access if I rolled the money out to a Roth IRA. Second, even though I am retired, lawsuits are a lifelong worry in my profession, and my lawyer tells me there is better creditor protection for me in the company plan than in a Roth IRA under my state's laws. The company 401(k) plan does allow "designated Roth accounts" (DRACs). Is there any way I can convert my 401(k) account to a "designated Roth account" within the plan, or is Roth IRA conversion my only option?

    Natalie: You must have a friend in Washington, heaven, or someplace. As of last month, it was impossible to do what you want to do; converting to a Roth meant converting to a Roth IRA and that was all there was to it.

    Now, the Small Business Jobs Act that was signed into law on Sept. 27, 2010, has created a new option, the "in-plan Roth conversion," effective immediately. If the plan is willing to permit it, the new law allows you to transfer existing balances in your traditional 401(k) account over to the "DRAC," thus converting to Roth status without ever leaving the plan. This type of conversion would be taxable just as a conversion to a Roth IRA would be taxable.

    Here are some key points about the new in-plan Roth conversions, with emphasis on differences between an in-plan Roth conversion and converting to a Roth IRA:

    • No Recharacterization Allowed. With a Roth IRA conversion, you can "recharacterize" (undo) the conversion any time until Oct. 15 of the year after the year of the conversion (assuming you file your tax return on time). In contrast, there is no option to recharacterize an in-plan Roth conversion. Recharacterization applies only to IRA contributions, and this is not an IRA contribution. Therefore, an in-plan Roth conversion is irrevocable. Because of that difference, it is probably preferable to use a Roth IRA conversion rather than an in-plan conversion unless (as in your case) there are strong reasons why you want to keep your money inside the plan.
    • Must Be Entitled to a Distribution. The in-plan conversion option will be available only to employees who (like yourself) are entitled to take distributions out of the employer plan. Thus, it will generally be available only to employees who either are over age 59½ or have separated from service, or whose plans permit "in-service distributions." Some employers may amend their plans to permit "in-service distributions" solely for the purpose of in-plan Roth conversions, but there will still be many employees who (because they are younger and/or still working) will be unable to use the in-plan conversion (just as they are unable to use a Roth IRA conversion because they can't access their plan funds).
    • Plan Must Offer DRACs. In-plan conversions are allowed only for plans that actually offer the DRAC option to their employees for their elective deferrals. A plan could not offer DRACs for rollover purposes without allowing it for purposes of ongoing contributions from salary reduction agreements.
    • Similar Rules to Roth IRA Conversions. Certain things will be just the same as Roth IRA conversions, namely, the ability to spread income resulting from a 2010 conversion forward into 2011 and 2012, and the 10% penalty tax that may apply if the individual withdraws from the converted funds less than five years after the conversion and while he is under age 59½.
    • What's Not Known. The Joint Committee's Technical Explanation mentions that this option is intended to be available to employees and their surviving spouses. The ability of a nonspouse Designated Beneficiary to use the option is unclear. Also unclear is whether plans will be willing to gear up and allow these conversions in 2010 without any regulations and without a plan amendment.
    • Government Plans. As of right now, the only types of plans that can offer DRACs are 401(k) plans and 403(b) plans. Again thanks to the Small Business Jobs Act of 2010, governmental 457(b) plans are added to the list of plans that can offer DRACS. However, this part of the law is not effective until 2011, so 457(b) plan participants will not be able to use the in-plan conversion option until 2011 at the earliest.

    See § 402A(c)(4), added to the Internal Revenue Code by the Small Business Jobs Act of 2010, and the Joint Committee on Taxation's Technical Explanation of the Tax Provisions in Senate Amendment 4594 To H.R. 5297, the "Small Business Jobs Act of 2010," (JCX-47-10) posted at http://www.jct.gov/publications.html?func=startdown&id=3707.

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