Reduced Restrictions on In-Plan Roth Rollovers

Among the changes and extensions in the recently enacted American Taxpayer Relief Act of 2012 (“Act”), one component that did not receive much buzz was the “in-plan Roth rollover” provision. This provision removes many of the restrictions on making a qualified rollover from a qualified plan to a designated Roth account with an in-plan Roth rollover.

Prior to the provision in the Act, if a retirement plan included a qualified Roth contribution program such as a Roth 401(k), Roth 403(b) or Roth 457, it could only be rolled over to a Roth account if it met certain criteria. To meet the requirements, a distribution had to be an eligible rollover distribution, allowed under the plan and allowable in the amount and form chosen. For example, if you were under 59 ½ years of age and enrolled in a 401(k) plan, you would not be eligible for any amount of distribution; therefore, your plan could not be rolled over into a Roth account.

Assuming your employer offers a qualified Roth contribution program and allows in-plan rollovers, the provision in the Act now allows you to convert your existing plan into a Roth account. It does not restrict the amount, and it does not require that the amount be eligible for distribution. The provision also allows for other vested assets to be rolled over, such as employer contributions, rollover accounts and employee after-tax contribution accounts.

With a non-Roth account like a 401(k), an employee is able to contribute pre-tax earnings to their retirement plan. Typically, once the participant reaches 59 ½, he or she may receive qualified distributions from the plan which are then taxed. In the case of a Roth account, participants are able to contribute post-tax earnings. After a five-tax-year holding period and assuming the participant has reached age 59 ½, the individual will be able to receive qualified distributions that can be excluded from gross income.

Something to keep in mind if you are considering an in-plan Roth rollover is while you will get the benefit of tax-free distributions down the road, you will be subject to income tax in the year of the rollover. Under this new provision, however, the rollover will not be treated as an early distribution, and you will not be affected by the 10% tax on early distributions. Additionally, unlike a traditional Roth rollover, once you complete an in-plan Roth rollover, it cannot be “unwound” at a later date via a recharacterization.

If employers choose to include this rollover option for plan participants, the new in-plan rollover option will most likely require further clarity from the IRS. According to the IRS website they, “anticipate issuing guidance later this year about the expanded in-plan Roth rollovers.”

While the initial cost to roll over your plan to a Roth account may seem high, it could be a good option for you in the long run. If you have any questions, please feel free to contact me at (805) 963-7811 or ecole@bpw.com.