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American Taxpayer Relief Act Eases Fund Transfers from Traditional to Roth 401(k) Accounts

January 11, 2013
One provision of the Act permits participants in a defined contribution plan, such as a 401(k) plan, to convert or transfer funds from a traditional IRA account in the plan into a Roth account in the plan without penalty, if the plan so permits.?á The transfer would not be subject to the 10 percent penalty on early distributions, such as if the participant is under age 59??, and would not violate the prohibition on such a plan not making a distribution before certain events occur.?á Contributions to a traditional 401(k) account are tax-deferred with the participant paying ordinary income tax when the money is ultimately distributed in retirement.?á In contrast, contributions to a Roth 401(k) account are taxed upfront with the subsequent distributions in retirement made tax free.?á Such in-plan Roth transfers could be beneficial to plan participants who expect to retire in a higher tax bracket as well as participants in a higher tax bracket who can afford to pay the tax now so that the additional earnings and appreciation in the account would be distributed tax free in retirement, provided they qualify for the special distribution treatment when the distribution occurs.?á This provision is effective for transfers after December 31, 2012.?á The Act did not change the requirement that the participant still must be able to pay the income tax on the in-plan Roth conversion out of non-plan assets (out of his or her cash on hand or in non-retirement plan savings) held by the participant.?á Plan sponsors should consider reviewing their plan documents to determine if the plan currently permits such in-plan Roth transfers or conversions and, if not, to consider the advisability of amending the plan to include such a feature.
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