The Internal Revenue Service is getting the word out to employers about a provision in the recently passed Small Business Jobs Act that allows them to amend their 401(k) or 403(b) plans to allow participants to transfer an eligible rollover distribution into a Roth 401(k) or 403(b) account.
Participants can transfer the eligible rollover distribution into a designated Roth account in the plan as long as the transfer is of an ERD
1. made after Sept. 27, 2010;
2. from a non-designated Roth account in the same plan;
3. because of an event that triggers an ERD from the plan; and
4. otherwise meets the rollover requirements.
The new law also permits sponsors of governmental 457(b) plans to add designated Roth accounts to their plans in taxable years beginning after 2010, and then these plans can be amended to allow in-plan ERD transfers to participants' designated Roth accounts if the ERD meets conditions 2 through 4 above.
If a participant rolls over an ERD into a designated Roth account, he or she must include any previously untaxed portion of the ERD in gross income. However, the rolled over amount is not subject to the additional 10% early withdrawal tax.
For 2010 only, if a participant rolls over an ERD into a designated Roth account in a 401(k) or 403(b) plan, he or she can include:
1. half of the taxable amount of the rollover in 2011 gross income and half in 2012 gross income; or
2. the entire taxable amount of the rollover in 2010 gross income.
A participant that elects to include the rolled over amount in his or her 2010 gross income may not revoke that election after the due date, including extensions, of his or her 2010 federal income tax return. The participant may also owe estimated taxes on the taxable amount of the rollover for the year or years it is included in gross income or may incur an underpayment penalty.
If people are still working and if they have substantial wealth in their retirement plan at work, this new legislation will be extremely important to them, said James Lange, CPA/JD, the author of Retire Secure! (Wiley, Feb, 2006 and 2009) This new legislation will essentially allow employees to convert their traditional 401(k) or 403(b) to a Roth designated account that would still be part of their employer retirement plan. Before, if retirement plan employees were working and their retirement plan was tied up in a 401(k), even if they wanted to make a large conversion, they werent allowed to because they didnt have access to their retirement plan. Now, assuming that employers already have or will add Roth designated accounts to their plans, employees can make, in effect, a Roth IRA conversion of whatever amount is appropriate."
For retirement plan owners in the top tax brackets, it will be more advantageous to make a 401(k) or 403(b) conversion to a Roth 401(k) or Roth 403(b) in 2010 than waiting until 2011 because we expect tax rates to go up at least for the upper income taxpayers in 2011, he added. Making a conversion while tax rates are lower is more advantageous because you will have to pay a lower tax on the conversion.
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