Fiscal Cliff Legislation Provides New In-Plan Roth Conversion Opportunity

This is a good summary of the change to 401k Roth Conversion Rules included in the legislation. – Reeve
by Brian M. Pinheiro and Josh Bobrin
The newly enacted American Taxpayer Relief Act (H.R. 8) includes a significant new
opportunity to perform “in-plan” conversions of pretax dollars to Roth
(after-tax) dollars of funds held in defined contribution retirement
plans (such as Section 401(k) plans, Section 403(b) plans, and
governmental 457(b) plans). President Obama signed the legislation on
January 2, 2013.

Plan sponsors who previously considered but rejected implementing an in-plan Roth
conversion feature for their plans due to the modest benefit previously
available to employees may now want to reconsider whether such an
approach makes sense in light of the greater benefits provided under the
new law.

For plan years beginning after December 31, 2012, employers will have the option, but
not the obligation, to amend their defined contribution retirement plans
to add (or expand) the new conversion feature. An in-plan Roth
conversion of pretax (non-Roth) plan assets causes the converted amounts
to become taxable in the year of the conversion, but allows any future
qualified distributions of the converted amounts, along with any
accumulated earnings, to be provided tax-free to the participant.

Prior to the passage of the Act, in-plan Roth conversions were available on a more limited basis.
Such conversions were only permitted for amounts that participants were
otherwise eligible to withdraw. In general, this meant that the amounts
eligible for conversion were limited to funds the participant had
rolled over from a prior plan and/or amounts the participant could
withdraw upon reaching age 59 ½. This resulted in a relatively small
pool of potential participants and assets that were eligible for the
in-plan Roth conversion.

Under the new, expanded conversion right, an eligible plan that permits regular
non-rollover Roth contributions could allow participants to convert any pre-tax
vested amounts to Roth amounts within the plan – whether or not
participants are eligible to withdraw such amounts. By broadening the
potential assets eligible for conversion to include previously
ineligible amounts, such as employee elective deferrals and employer
matching contributions, the new law provides participants with a much
higher potential base from which they can choose to convert to after-tax

Additional guidance will be needed to confirm how the expanded conversion right
will be carried out. It is likely that the new conversion right will
operate in the same manner as existing in-plan Roth conversions under
IRS Notice 2010-84, but this has not been confirmed by the IRS.

If you have questions regarding the new Roth conversion opportunity provided by the American
Taxpayer Relief Act and how it may affect your retirement plan, please
feel free to contact Brian M. Pinheiro at 215.864.8511 or, Josh Bobrin at 215.864.8409 or, or any member of Ballard Spahr’s Employee
Benefits and Executive Compensation Group.