The fiscal cliff-delaying American Taxpayer Relief Act contains an important provision that provides a new opportunity for participants in defined contribution plans that permit Roth elective deferrals, including 401(k), 403(b) and governmental 457(b) plans, to convert their vested balances to Roth accounts. Prior to this legislation, only amounts in traditional retirement plans that were eligible for rollover distributions (i.e., generally for participants who were at least age 59½) could be converted to Roth accounts if the plan otherwise permitted Roth contributions. Now, amounts held in these plans may be converted to Roth accounts regardless of whether there is a distributable event, so long as the plan otherwise permits Roth contributions.
Roth conversions allow participants to pay taxes now on defined contribution plan balances. Any growth in the value of the accounts will not be taxed when the participant begins qualified distributions. While this means that the participants will need to fund the current tax bill from assets outside of the plan, it protects those distributions from being taxed at possibly higher future marginal rates. Newer plan participants with lower current balances and more time for those assets to grow may find the conversion option especially attractive.
This provision is effective immediately on January 1, 2013 and is optional for plan sponsors. The Act dramatically increases the ability of plan participants to make Roth conversions. However, the Act does not address the details of implementation. Therefore, employers most likely will wait for additional guidance before allowing participants to make Roth conversions under the new provision. Employers should watch for guidance from the Internal Revenue Service, which is expected to expand on and generally confirm the guidance provided under IRS Notice 2010-84 with respect to Roth conversions prior to the Act. In addition, employers that do not currently permit Roth contributions may be persuaded by this provision to amend their plans to allow such contributions.