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Roth IRA Conversion – Transfer or Rollover : Under ATRA, Roth Conversion could be Transfer or Rollover

Roth IRA Conversion: Transfer or Rollover?

Under the American Taxpayer Relief Act of 2012 (ATRA), an in-plan Roth 401(k) conversion now may be made as a transfer rather than as a rollover. This new provision means there does not need to be a distributable event for participants to move pretax 401(k) contributions into a Roth account with the same plan.

In-plan Roth Rollover

The Small Business Jobs and Credit Act of 2010 (SBJCA) created the in-plan Roth conversion, which permits 401(k) plans (and other “applicable retirement plans”) that have Roth account provisions to allow participants (or surviving spouses) to convert non-Roth accounts to Roth accounts within the 401(k) plan. Note that since funds are not distributed from the plan, the income taxes due as a result of the conversion must be paid from a participant’s other assets.

There are some restrictions, however. The in-plan Roth rollover conversion is available only to participants who are eligible for a distribution from the plan. Thus, participants are not eligible to convert elective deferrals, safe harbor 401(k) contributions, qualified nonelective contributions (QNECs), or qualified matching contributions (QMACs) to a Roth account until they reach age 59 1/2. And employer matching and nonelective contributions cannot be converted unless the plan has an in-service distribution provision.

In-plan Roth Transfer

By adding the in-plan Roth transfer, ATRA eliminated the requirement that participants must have a distributable event to move pretax amounts into a Roth 401(k) account. Amounts in non-Roth accounts can now be converted by transfer. As with any Roth conversion, participants who transfer pretax amounts to after-tax Roth 401(k) accounts must pay federal income tax on the transferred amount in the year the conversion occurs.

Amending the Plan

In-plan transfers are permitted only when the plan document contains or is amended to provide a Roth elective deferral feature. A plan sponsor cannot add a Roth account feature solely to allow for Roth rollovers or transfers.

Although the new law permits in-plan Roth transfers as of January 1, 2013, at press time, the IRS had yet to issue guidance on this new law change. However, based on established guidance, if a plan sponsor wishes to permit the in-plan Roth transfer, the plan document must be amended by the end of the plan year in which a Roth transfer is first permitted. Therefore, sponsors of calendar-year plans who wish to permit transfers this year will need to amend their plan by December 31, 2013. Prior to amending their plan, employers wishing to add this feature should draft a board resolution.

Note: Separate recordkeeping of each transfer is needed for reporting purposes and to track the five-year recapture tax rules.

Please contact Jerry Smith at 731.642.0771 for more information.