It’s getting a lot of press. “It” is the provision in the recently passed American Taxpayer Relief Act of 2012 that now allows participants in 401(k) plans to convert existing traditional 401(k) balances to Roth 401(k) balances.

As an advisor, following are some questions your clients may ask you (with some suggested responses): 

What exactly does “In-Plan” mean? 

Under prior law, participants could not transfer amounts from traditional 401(k) accounts to Roth accounts in the same plan until they attained age 59½ or left their employer. The new law allows participants to make the transfer from a traditional 401(k) account to a Roth retirement plan account at any time. 

Is there a limit on how much can be transferred from the traditional 401(k) to the Roth 401(k) account

No. 

What are the tax consequences? 

The conversion is taxable, but participants who are currently in lower tax brackets may want to pay the tax now so they can take tax-free distributions at a later date. 

When does the tax have to be paid? 

The tax liability is incurred in the current year of conversion. Unlike the 2010 law in which In-Plan Conversions were first permitted, the tax cannot be spread over two years.  

What’s needed for a plan to permit In-Plan Conversions?

Like all things ERISA, it starts with the plan document. If a plan doesn’t currently offer participants a Roth contribution account, the plan would have to be amended to add Roth contribution accounts and add a new provision for participants to make the conversion. If Roth is already part of the plan, then just the new option would have to be added?

Exactly how is the Roth provision added to a 401(k) plan?

Here’s what a plan sponsor has to do in conjunction with its advisor and TPA:

  1. Amend the plan to include Roth.
  2. Update the Summary Plan Description.
  3. Provide educational materials to employees.
  4. Modify the payroll system for after-tax contributions and the conversion
  5. Confirm that the plan recordkeeper can separately account for Roth contributions

Which 401(k) participants should consider either contributing to a Roth 401(k) account or converting an existing traditional 401(k) account to a Roth 401(k)? 

We’re only the TPAs. Helping clients with the decision is just one more way for advisors to add value. 

Here is a link to additional FAQs about Roth 401(k).

This information should be considered general in nature and does not constitute legal or tax advice. Taxpayers should always consult their tax advisor before making a decision regarding their 401(k) account. 

Jerry Kalish is President of National Benefit Services, Inc., a Chicago-based TPA firm. He also publishes the firm’s Retirement Plan Blog. He can be reached at jerry@nationalbenefit.com.

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