Roth conversions within 401(k)

[Guest KRS401k]

My boss read somewhere that a regulation was passed this summer allowing Roth conversions within the plan. I cannot find anything regarding this. Is this still in the proposal phase and not officially passed? Does anyone have a link to information regarding this?

Thanks!

[Jim Norman]

It survived a cloture vote in the Senate yesterday and is expected to pass in the Senate this week. House is expected to pass it next week.

[masteff]

allowing Roth conversions within the plan.

But... it doesn't allow them "within" the plan. Rather it permits rollovers to Roth accounts from a regular QP. So a person would still have to be eligible for a distribution before it could be used. Full text can be found here: http://finance.senate.gov/legislation/deta...29-92cebbd2b7a0 (the legislative text, beginning at page 164)

[12AX7]

Wouldn't Notice 2009-75 allow for the direct rollover to a Roth IRA for non-roth accounts, where you would otherwise have a distributable event? I think the intent of the HR 5297 is to allow for in-plan conversions, but that's not particularly clear from reading the Legislative Text.

[Guest Sieve]

The proposed legislation allows a conversion rollover from a participant's non-Roth account in a qualified plan to the participnat's Roth account in the same plan, as long as there is a "distribution" (i.e., a distributable event, such as attaining age 59-1/2):

"In the case of an applicable

retirement plan [i.e., a qualified plan] which includes a qualified Roth

contribution program,

this paragraph shall

apply to a distribution from such plan

other

than from a designated Roth account

which is

contributed in a qualified rollover contribution

(within the meaning of section 408A(e))

to the

designated Roth account maintained under such

plan for the benefit of the individual to whom

the distribution is made

." (Emphasis added.)

[Tom Poje]

apparently this has passed the Senate

http://www.businessinsurance.com/apps/pbcs.../NEWS/100919932

[mbozek]

allowing Roth conversions within the plan.

But... it doesn't allow them "within" the plan. Rather it permits rollovers to Roth accounts from a regular QP. So a person would still have to be eligible for a distribution before it could be used. Full text can be found here: http://finance.senate.gov/legislation/deta...29-92cebbd2b7a0 (the legislative text, beginning at page 164)

The proposal allows conversion to a Roth account within the plan so that a distribution would not be necessary. The purpose of this provison is to prevent participants from withdrawing funds from 401k plans which reduces the fees collected by the plan.

The proposal woudl also allow Roth accounts in 457b plans (I dont know if this is limited to govt 457bs).

[masteff]

The proposal allows conversion to a Roth account within the plan so that a distribution would not be necessary.

Sorry to disagree but must have a distribution per the proposed new 402A©(4)(B) in the bill:

‘‘(B) DISTRIBUTIONS TO WHICH PARAGRAPH APPLIES.—In the case of an applicable retirement plan which includes a qualified Roth contribution program, this paragraph shall apply to a distribution from such plan other than from a designated Roth account which is contributed in a qualified rollover contribution (within the meaning of section 408A(e)) to the designated Roth account maintained under such plan for the benefit of the individual to whom the distribution is made."

[mbozek]

The proposal allows conversion to a Roth account within the plan so that a distribution would not be necessary.

Sorry to disagree but must have a distribution per the proposed new 402A©(4)(B) in the bill:

‘‘(B) DISTRIBUTIONS TO WHICH PARAGRAPH APPLIES.—In the case of an applicable retirement plan which includes a qualified Roth contribution program, this paragraph shall apply to a distribution from such plan other than from a designated Roth account which is contributed in a qualified rollover contribution (within the meaning of section 408A(e)) to the designated Roth account maintained under such plan for the benefit of the individual to whom the distribution is made."

I agree that the conversion is a regarded as a distribution for tax purposes in order for revenue to be collected (which is true for all conversions to a Roth) but as I understand it there is no distribution from the plan. The language you cite confirms that the pre tax assets are distributed/converted to a Roth account in the same plan. The Roth account is subject to all rules for qualified plans such mandatory distributions at 70 1/2, spousal consent for designation of another person as bene, QDROs, etc.

[masteff]

We'll have to disagree until we get clarification. Since this has tax implications for this tax year, I'm sure the IRS will be on this one faster than normal.

[mbozek]

We'll have to disagree until we get clarification. Since this has tax implications for this tax year, I'm sure the IRS will be on this one faster than normal.

But it needs to be enacterd first. There will be time to worry about what it means when it is enacted.

I dont understand what you are trying to say. Are you saying that the conversion/distribution of a pre tax account to a Roth account in the same plan is a distribution that removes the Roth account from the plan so as to eliminate provisions that apply to other Q plan funds, eg. protection from creditors?

[Guest Sieve]

masteff -- There must be a distibutable event in order for the conversion to apply, so an in-service conversion of elective deferral $$ could not occur unless the participant was eligible for such a distribution (e.g., if he/she was over age 59-1/2 in a plan which permits a distribution at age 59-1/2). And, the conversion/rollover will be treated as a distribution (1099 issued, etc.) for tax purposes. But, a physical distribution is not necessary. My understadning, as stated by mbozek, is that this provision is intended to permit conversions to Roth without qualified plans losing their assets to IRAs. It's a direct rollover, but just within the same plan.

[masteff]

I agree that the conversion is regarded as a distribution for tax purposes in order for revenue to be collected (which is true for all conversions to a Roth)

I think we're all agreed on this point.

but as I understand it there is no distribution from the plan.

I think we have disagreement on this point. I think Sieve and I agree there must be a distributable event (and subsequent rollover contribution back into the plan). Whereas mbozek states here that he thinks there's no distribution. The difference being who can take advantage of this: can anyone do it or only those who otherwise qualify under plan provisions for a distribution.

Edit: ahhh, just got Sieve's last point... a paper distribution versus a physical distribution. Okay, I'll buy that nuiance, that it could be done as a recordkeeping entry. But I do still think (and think I'm reading Sieve to say the same thing) that there must be a qualifying event for it to occur (which is really the point I've tried to make and indeed my first post above I said "eligible for a distribution").

[Bird]

Yes, there must be a distributable event. But it doesn't have to be a physical distribution.

[masteff]

For what it's worth -- I'd think it better to refer to the process as a "back office" distribution rather than to suggest there is no distribution... the semantic between a "distributable event" and a "distribution" is too fine especially given the current version of the bill uses the explicit words "distribution" and "contribution". Just look at the frustrating arguing we wasted here because of that nuiance.

EDIT: Just did a search of the full IRS Code ( http://uscode.house.gov/download/title_26.shtml )... the term "distributable event" does not exist. That is a construct of people interpreting the Code. People above making points about "distributable events" are able to do so because the Bill in question states that these are "distributions" and we are able to then determine which rules and restrictions apply.

[austin3515]

Why do I have a feeling the authors of the bill probably couldn't even answer the question?

[Guest jims]

I'm on the page with Sieve that these are "paper distributions" or "back office distributions" and in-service withdrawals and regular distributions are the distributable events. If a plan already allows for designated Roth contributions and accepts rollovers in of Roth money, what more is needed for a plan to actually do this when(assuming) it is enacted? Will it need specific plan document changes, or is the new law just clarifying what is an allowable Roth rollover which the plan already accepts?

When (assuming) this is enancted, there will likely be a small vocal minority of participants wanting to convert in 2010 in order to have the income spread over 2010 and 2011. That will put pressure on administrators to react quickly, but may be hard to be ready.

[Guest Sieve]

To clarify . . . Under the legislation, in order for $$ to move from a non-Roth account to a Roth account within the same plan, there must be some kind of in-service distribution of the non-Roth permitted by the terms of the Plan (by amendment, if necessary), such as at age 59-1/2 (if elective deferrals) or even earlier (if non-elective deferrals, such as PS or match contributions) or at termination of employment.

Unless the Plan actually provides for and permits a distribution on an appropriate distributable event (so that a participant can actually remove $$ from the plan when that event occurrs) then a conversion/rollover from non-Roth to Roth cannot occur. If I have led some to believe that the plan need not specifically provide for an in-service distribution, then I apologize, because it must--my earlier post indicated that a distributable event must occur in a plan which permits such a distribution. (I believe, however, that such in-service distributions can be limited, by the terms of the plan, only to a conversion/rollover into a Roth account in the same plan).

[Guest jims]

Sieve, I'm still with you. I should have stated my questions better about the current state of the plan.

Assume the terms of a plan already:

-Allows for designated Roth contributions,

-Accepts Roth rollovers,

-Allows in-service withdrawals (e.g. age 59 1/2 withdrawals)

If this is enacted, would said plan be ready to allow the Roth conversion in the plan? Is the new rule effectively exanding the definition of a Roth rollover. Or does plan somehow need further amendment to adopt this new rule?

In the above assumed plan, would the example 60 year old participant be able to 'take' an inservice withdrawal and turn it into Roth rollover money right after enactment?

Bonus question: Can this participant 'withdraw' $10,000 taxable funds and end up with $10,000 Roth rollover? Or will they somehow get stuck with mandatory tax withholding that reduces the Roth rollover to something less than $10,000?

Thanks for all input.

[Guest Sieve]

I assume that there will have to be some amendment to the plan to permit the in-plan rollover into a Roth account. At this time, I don't think that you can rollover anything other than a Roth account into a qualified plan's Roth account--i.e., I believe that this potential new conversion-rollover within the plan will be the only conversion-rollover permitted into a Roth account from a non-Roth account. So, I don't think your Plan currently will allow a rollover into its Roth account except from another Roth account, so an amendment would be necessary to permit any in-plan conversion-rollover. Here is what Corbel's current Roth amendment says:

"The Plan shall accept a rollover contribution to a Participant's Roth Elective Deferral account only if it is a direct rollover from another Roth Elective Deferral account of an applicable retirement plan as described in Code Section 402A(e)(1) and only to the extent the rollover is permitted under the rules of Code Section 402© . . ."

Also, if it's a direct rollover, then there shouldn't be 20% mandatory withholding (even if part ofthe direct rollover is otherwise taxable because the holding period has not been met).

[K2retire]

Am I the only one wonder what the point of this legislation is if you can't convert before age 59 1/2? Isn't the conventional wisdom that a Roth conversion benefits younger people most?

[John Feldt ERPA CPC QPA]

The proposal woudl also allow Roth accounts in 457b plans (I dont know if this is limited to govt 457bs).

Yes it would apply also to 457(b) pans, but only government-sponsored 457(b) plans since a tax-exempt (non-profit) sponsored 457(b) plan's distribution is not eligible for rollover.

I think it could be possible to amend a plan to lower the age for in-service eligibility (or to remove the age minimum) and limit such in-service "distribution" option such that it only applies to in-plan Roth conversions. Of course I am only speculating.

[mbozek]

Am I the only one wonder what the point of this legislation is if you can't convert before age 59 1/2? Isn't the conventional wisdom that a Roth conversion benefits younger people most?

The purpose of this legislation is to create a revenue gain for the amount of funds converted by participants to a Roth 401k by year end and over the next 9 years to allow Congress to reduce taxes on small businesses before the November election. Note Roth accounts would be permitted in 457b plans which is projected to gain $1B. Employers have been pushing for this legislation because employees who are eligible for inservice withdrawals are increasing the transfer of funds from 401k plans to Roth IRAs which reduce the amounts available to pay the fees under the plan. These employees believe that their taxes will increase next year and in retirement so they are paying taxes now to avoid future tax increases (even though most will be in a lower bracket in retirement) regardless of the message from inside the beltway that tax rates will not increase for taxpayers below the 33% bracket ($200k). They also expect Roth conversion to reduce income tax on their SS benefits. Others are converting so that they will not have to take MRDs.

I concur with the analysis that the funds transferred to the Roth 401k plan must remain in the plan in order to preserve all of the attributes of a qualfied plan, e.g, protection from creditors, MRDs, etc. I expect the legislation will define who will be eligible to make the transfers in a manner consistent with existing legislation and regulations. But I am going to wait until the law is enacted.

[Guest elang]

Am I the only one wonder what the point of this legislation is if you can't convert before age 59 1/2? Isn't the conventional wisdom that a Roth conversion benefits younger people most?

I was curious if there has been any clarification on this subject. Is an "in plan" conversion available to those under the age of 59 1/2?

Thanks

[Guest Sieve]

Yes, if the converted account is a non-deferral account (e.g., non-elective PSP) where age 59-1/2 is not the minimum age when distributions are permitted. But, for an elective deferral account, an in-service distribution is not permitted until age 59-1/2 (since a hardship distribution cannot be rolloved over).

[Nassau]

On September 27, 2010, President Obama signed the Small Business Jobs Act (the “Act”) into law. The Act contains a provision that would allow for in-plan conversions to Roth. This provision was effective immediately upon enactment and has no deadline for adoption. A few key provisions of the Act include:

Only plans that permit Roth deferrals can offer in-plan conversions.

Offering in-plan conversions is optional for plans with a Roth feature. Plans must be amended to offer in-plan Roth conversions. The IRS is expected to provide a remedial amendment period, but the timeframe is not yet known.

In order to convert, a participant must have a “distributable event” from their retirement plan, such as termination from employment or the availability of in-service withdrawals. Only eligible rollover distributions can be converted (e.g., hardship and required minimum distribution payments cannot be converted).

The taxable portion of the distribution must be included in gross income in the year of conversion, except for conversions occurring on or before December 31, 2010.

o For 2010 conversions only, participants can elect to include the taxable amount in income equally over 2011 and 2012 or include it in income for 2010.

[Guest elang]

Yes, if the converted account is a non-deferral account (e.g., non-elective PSP) where age 59-1/2 is not the minimum age when distributions are permitted. But, for an elective deferral account, an in-service distribution is not permitted until age 59-1/2 (since a hardship distribution cannot be rolloved over).

So just to clarify, so long as a 401(k) Plan allows for In Service Distributions and ROTH deferrals, the Non-Elective PSP portion is able to be converted to a ROTH acct for participants under 59 1/2?

[Guest Sieve]

If the Plan provides that PS accounts can be distributed (or can be converted to an in-Plan Roth account) as of, say, age 55, then a conversion is permitted. In other words, the conversion can only occur with respect to accounts that the participant is otherwise eligible to receive in an in-service distribution--and the distribution can be limited, per plan terms, to an in-plan conversion only).

[masteff]

The IRS website now has a page on this topic. http://www.irs.gov/retirement/article/0,,id=228390,00.html