Deep within the Small Business Jobs Preservation Act signed into law by the President is a provision that can be of significant value to 401(k) plan participants. In essence, this provision allows individuals to transfer otherwise distributable money from the 401(k) pre-tax account to a Roth account within the same 401(k) plan. The Roth 401(k) is an option in many employer plans. This transfer is available now if permitted by the employer’s plan and the plan has a Roth account within it.
If a transfer is made, it is treated as a distribution for tax purposes (but the 10% early withdrawal penalty (IRC Section 72t) does not apply. The money is not actually distributed but transferred to the Roth account within the 401(k) minus the taxes that are paid. Thereafter, the earnings on the Roth 401(k) are tax-free.
Taxes are actually payable over a two-year period; in this case, they are paid in 2011 and 2012. However, because of the possibility of at least some income taxes going up in 2011, higher income individuals may want to have the tax paid in 2010. See an expert on this matter.
If your 401(k) has been hit by the stock market fall converting to a Roth using the same investment funds within your 401(k) may be one way to improve your retirement income in the years ahead as you will have tax-free income to draw from. Balancing the loss of funds from paying taxes today against the value of tax-free earnings down the road can be tricky, but it is certainly worth the time to figure out what is best for you.
If your 401(k) plan contains a Roth today, you may want to ask your employer to implement this provision as soon as possible so that you have the option before year-end. Remember, many if not most 401(k) plans charge you for plan administrative costs so making this adjustment to the plan probably will not cost your employer anything. It’s a good thing!
More information can be found in a memo released by the Groom Law Group
Text of the Law
SEC. 2112. ROLLOVERS FROM ELECTIVE DEFERRAL PLANS TO DESIGNATED ROTH ACCOUNTS.
(a) In General- Section 402A(c) of the Internal Revenue Code of 1986 is amended by adding at the end the following new paragraph:
`(4) TAXABLE ROLLOVERS TO DESIGNATED ROTH ACCOUNTS-
`(A) IN GENERAL- Notwithstanding sections 402(c), 403(b)(8), and 457(e)(16), in the case of any distribution to which this paragraph applies–
`(i) there shall be included in gross income any amount which would be includible were it not part of a qualified rollover contribution,
`(ii) section 72(t) shall not apply, and
`(iii) unless the taxpayer elects not to have this clause apply, any amount required to be included in gross income for any taxable year beginning in 2010 by reason of this paragraph shall be so included ratably over the 2-taxable-year period beginning with the first taxable year beginning in 2011.
Any election under clause (iii) for any distributions during a taxable year may not be changed after the due date for such taxable year.
`(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.
`(C) COORDINATION WITH LIMIT- Any distribution to which this paragraph applies shall not be taken into account for purposes of paragraph (1).
`(D) OTHER RULES- The rules of subparagraphs (D), (E), and (F) of section 408A(d)(3) (as in effect for taxable years beginning after 2009) shall apply for purposes of this paragraph.’.
(b) Effective Date- The amendments made by this section shall apply to distributions after the date of the enactment of this Act.