Tip of the day
By Stephanie Reagan
An in-plan Roth conversion allows a participant to elect to change the tax treatment of all or a portion of his or her pre-tax or after-tax accounts.
The taxes on the contributions and earnings in the pre-tax accounts are deferred until a distribution is made. With a Roth account, one pays current taxes on the amounts contributed.
When a distribution is made from the Roth account, there are no taxes on the amounts one has contributed. If the participant has a qualified distribution (see our Blog post dated March 10, 2015 for more information on the taxation of in-plan Roth conversions), there are no taxes on the earnings that are attributable to the contributions.
An in-plan Roth conversion allows a participant to transfer amounts from their vested accounts pre-tax or after-tax accounts to an in-plan Roth conversion account. If one elects to make such a transfer, then the amount transferred will be included in the participant's income for the year transferred. Once an election is made it can't be changed. It's important that adequate cash is available outside of the plan to pay the additional taxes.
Plan Accounts That Can Be Converted
Usually there is confusion regarding what accounts can be converted in an in-plan Roth conversion because there are two laws that come into play here.
2010 Provision (Notice 2010-84) - Vested Non-Roth Distributable Unrestricted Amounts
The 2010 Roth conversion rules allow a plan to add the provision only for vested non-Roth distributable unrestricted amounts. The unrestricted amounts must be immediately distributable (able to be distributed at any time) such as:
- Rollover accounts,
- Amounts that are eligible for in-service withdrawal(s) under the plan's terms, such as the attainment of age 59 ½, and
- After-tax account money
2013 Provision (Notice 2013-74) - Vested Non-Distributable Restricted Amounts
Beginning January 1, 2013, the government added a provision which additionally allows a Roth in-plan conversion for vested, non-distributable restricted amounts. Now, assets do not need to be distributable to be eligible for conversion, but all assets converted must maintain the integrity of the original source distribution restrictions. That is, the assets must remain non-distributable in the new Roth source.
Currently Eligible Asset Sources Eligible for Roth Conversions
Roth in-plan conversions may now be made from any account other than from a designated Roth account. An in-plan Roth conversion could be made from any of the following sources, restricted or unrestricted:
• Pre-tax salary deferrals
• Employer matching contributions
• Employer profit sharing contributions
• Eligible rollover contributions
• Old money purchase pension money
• Non-elective contributions
• After-tax contributions
Note that some vendors will not allow in-plan conversions from restricted account assets or they may limit the number of restricted asset accounts that can be converted because there is a lot of recordkeeping involved.
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