By Ian Berger, JD
IRA Analyst
In the January 5 edition of the Slott Report, we mentioned that the federal Thrift Savings Plan (for government workers and the military) started offering in-plan Roth conversions on January 28. This article will provide more information about in-plan Roth conversions generally – how they work, their availability, their tax consequences, and who can most benefit from them.
What is an in-plan Roth conversion? It’s a transfer of funds from your non-Roth 401(k) buckets (e.g., pre-tax elective deferrals, non-Roth after-tax contributions and employer matches) to a Roth account within the same plan. Besides active employees, in-plan conversions can be made by former spouses and surviving spouse beneficiaries with a plan account. Conversions cannot be done by non-spouse 401(k) beneficiaries.
In-plan Roth conversions are available to employees in 401(k), 403(b) and governmental 457(b) plans that permit them. (For the sake of simplicity, references in this article to “401(k) plans” mean 401(k), 403(b) and governmental 457(b) plans.)
In-plan Roth conversions are optional for plans. According to a recent report by the Plan Sponsor Council of America, 56% of surveyed plans allow in-plan conversions at any age, while 6% allow them only at age 59½ or older. So, be sure to check with your plan administrator or company HR to see if in-plan Roth conversions are allowed. By contrast, Roth IRA conversions are always available to traditional IRA owners. Roth IRA conversions are also available to inherited 401(k) beneficiaries, but not to inherited IRA beneficiaries.
When you convert funds in pre-tax 401(k) buckets, the conversion is fully taxable to you in the year you do the conversion. However, when you convert funds in a separate after-tax bucket, only part of the conversion is taxable. The conversion is taxable in the same proportion that after-tax earnings in your after-tax bucket bear to the total balance in that bucket. Note that Roth IRA conversions of after-tax amounts are taxed differently. All of your IRAs, including SEP and SIMPLE accounts, are considered in determining the taxable portion of the conversion.
It’s important to remember that once you do an in-plan Roth conversion, it cannot be undone. This means you must have the funds available to pay that year’s tax bill. You also may need to start making quarterly estimated payments to the IRS (or increase existing estimated taxes). Be sure to check with your financial advisor or CPA.
If you’re under 59½, working for a company with a 401(k) plan and want to boost your Roth savings, an in-plan Roth conversion may be an especially good idea. That’s because you normally can’t get access to your pre-tax plan savings in order to do a Roth IRA conversion while you are still employed. But if the plan allows, you can get those funds into a Roth 401(k) account through an in-plan conversion.
If you have technical questions you would like to have answered, be sure to submit them to [email protected], to be answered on an upcoming Slott Report Mailbag, published every Thursday.