The new fiscal bill, the American Taxpayer Relief Act of 2012, includes a provision that adds more flexibility to Roth retirement accounts.
Now, individuals can convert their existing 401(k) retirement plan to a Roth 401(k) — assuming their employer offers the Roth version, and allows conversions — regardless of whether they are eligible to take distributions out of the plan.
Previous rules allowed conversion from a 401(k) plan to a Roth version only if you were eligible to take funds out of the account. That meant, in general, that you had to be 59 and a half, dead, disabled or had left the employer (unless the plan allowed “in service” withdrawals), said Michael Kitces, a financial planner who summarized the change in his blog.
“It wasn’t very useful for most people,” he said. But now, he added, “Even if you still work there, and are younger than 59 and a half, you can do conversions.”
Investors who convert from a traditional, tax-deferred account to a Roth account do so because they have decided it’s preferable to pay taxes on their contributions now and avoid paying them later, when tax rates are likely to be higher. (Employee contributions to Roth 401(k)’s are taxable, but withdrawals are tax free.)
Essentially, Mr. Kitces said in his blog, the new rule means you can now do “intra-plan” 401(k) conversions “from traditional to Roth in the same manner you can do so for I.R.A.’s.”
The change doesn’t necessarily mean there will be a rush of people converting their 401(k)’s, he said. For one thing, your employer has to offer Roth 401(k)’s. (About 40 percent of employers do, according to the benefits consultants Aon Hewitt.) And as with I.R.A. conversions, you have to have the money to pay the taxes on the conversion. “We certainly expect to see some people take advantage,” he said, “but don’t expect an onslaught of conversions due to this provision.”
Alison Borland, vice president for retirement solutions and strategies at Aon Hewitt, noted that it’s optional for companies to offer Roth 401(k) plans, and it’s also optional for them to offer conversions. But the new rules may make conversions more compelling to employees, she said, so there may be more incentive for companies to allow them.
Previously, she said, the amount to be converted was subject to annual limitations on retirement plan withdrawals, which can vary by employer. But under the new provision, she said, employees can convert the entire balance in their plan to the Roth version.
“I do think this will give more plan sponsors a reason to add it,” she said. She also noted that companies will probably need additional guidance from the I.R.S. before they actually begin to allow conversions.
Would you consider converting your 401(k) to a Roth version, if you’re given the opportunity?