Fiscal Cliff Deal Expands Roth 401(k) Conversion Eligibility

California Estate Planning Attorney Kavesh Minor & Otis

“This is a big deal,” says Alison Borland, vice president of retirement solutions and
strategies for Aon Hewitt. “It will open up the door for many workers who will be able to benefit.”

If your employer offers a traditional 401(k) retirement plan, you may want to ask if there are plans to also offer the Roth 401(k), and the option of converting a traditional pre-tax plan to a Roth plan. The new American Taxpayer Relief Act (aka Fiscal Cliff Deal) expands eligibility for these conversions, and, depending upon your circumstances, paying the tax now just might be financially savvy in the long-term.

Clearly, Congress is hoping to raise some revenue by allowing these taxable conversions. And while it may seem counter-intuitive to pay the tax now, there are situations in which a 401(k) Roth conversion makes sense. Here’s how it works: the new rules basically let you convert everything in a traditional 401(k), including pre-tax salary deferrals, at any age, into a Roth 401(k). You pay income tax on the amount you convert. Your new Roth account continues to grow tax free and the eventual distributions also are tax free. According to Forbes, “a Roth conversion makes sense if you expect your tax rate to be the same or higher in retirement and won’t need the funds for a decade or more. It’s also an attractive way to leave an income-tax-free inheritance to your kids or grandkids.“

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As with all tax and retirement planning strategies, there are a few caveats:

Unlike the traditional IRA Roth conversion rules, there is no option to split your tax bill over two years. You will owe the entire tax on whatever amount you convert (remember, Congress is trying to raise some revenue here!).
Also unlike traditional IRA Roth conversions, you cannot un-do your conversion next year if you change your mind. Your 401(k) conversion is permanent.
Both the Roth 401(k) plan and the conversion option must be included in your employer’s plan offering for you to take advantage of this strategy.

Forbes has a handy online slide show outlining 10 reasons you might want to convert to a Roth IRA. If any of these fit your situation, be sure to consult with a qualified retirement planning and tax specialist before making a move.

For more information on IRAs and 401(k) planning please visit my estate planning website.

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Philip J. Kavesh

Nationally recognized attorney helping clients with customized estate planning guidance for over 40 years.

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