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