A Rule to Help You Build Your New Three Legged Stool™ - Rodgers & Associates

A Rule to Help You Build Your New Three Legged Stool™

A feature in the American Taxpayer Relief Act of 2012 allows company plans (401(k), 403(b) and 457(b)) to permit partic­i­pants to convert pre-tax contri­bu­tions to Roth account balances. This provision provides partic­i­pants with additional flexi­bility to help reach retirement with a properly balanced New Three-Legged Stool™. Those partic­i­pants who convert all or part of a pre-tax account are required to pay taxes on the amount in the year of the conversion, just like converting a tradi­tional IRA to a Roth.

Building a tax efficient New Three-Legged Stool success­fully takes prepa­ration. Many employees believe saving in an employer-sponsored plan is the easiest way to disci­pline themselves to put money aside for retirement. Having the ability to save pre-tax and after-tax in a Roth provides a valuable way to save tax efficiently. Conver­sions may appeal to partic­i­pants who do not expect their tax rate to be lower in retirement. They may also choose to make the conversion in a tax year which is unusually low for them. The conversion feature should appeal to younger partic­i­pants who have a lot of time ahead of them, while their accounts can grow tax-free.

Partic­i­pants should seek qualified tax advice before electing to convert. While conver­sions are not subject to the 10% early distri­b­ution tax, the amount converted is taxable. Effective January 1, 2018, following the Tax Cuts and Jobs Act, a conversion from qualified plans cannot be rechar­ac­terized, meaning the employee cannot convert back to pre-tax if they discover the conversion did not work out the way they planned. 

You will need to check with your employer to determine if they have elected to adopt this feature in your plan. The existing plan must allow Roth deferrals. Your company will need to add Roth deferrals before partic­i­pants may convert any existing balances. If your plan already allows Roth deferrals, it is likely they have adopted the conversion feature.

Origi­nally published June 2013