Expanded Roth Conversion Opportunity

EXPANDED ROTH CONVERSION OPPORTUNITY AVAILABLE TO RETIREMENT PLAN PARTICIPANTS; FIDUCIARY UPDATE

January 24, 2013

Expanded Roth Conversion Opportunity

The recently enacted American Taxpayer Relief Act of 2012 provides retirement plan participants an expanded opportunity to convert pre-tax money in 401(k) and other retirement plan accounts into after-tax “Roth accounts.” Although the amount converted is immediately taxable, later qualifying distributions from a Roth account are tax-free.

Under prior law, plans could allow participants to convert their pre-tax accounts to after-tax Roth accounts only if those funds were eligible to be distributed from the plan. This restriction meant that participant 401(k) deferrals and certain employer non-elective and matching contributions could not be converted until the participant reached age 59½.

Beginning in 2013, a plan may begin allowing all account balances to be converted at any time, regardless of the participant’s age or whether the funds are eligible to be distributed from the plan. Plans must still be amended to provide for the conversion under the new rule.

The expanded opportunity to make a Roth conversion may become more attractive to participants who are not yet eligible to take a distribution. For example, a younger participant in a lower tax bracket may wish to convert pre-tax funds to a Roth account. Based on current tax law, a participant could potentially pay tax today at a 15% federal income tax rate, let the Roth account grow over several decades and then withdraw Roth funds tax free in retirement, regardless of how high income tax rates may be at that time. Other participants with substantial retirement plan assets may wish to make a Roth conversion for estate planning purposes.

The expanded Roth conversion rule also applies to 403(b) plans and governmental 457(b) deferred compensation plans. Retirement plan sponsors may wish to consider amending their retirement plans to provide participants this new opportunity.

Fiduciary Update

The Department of Labor (“DOL”) has recently been stepping up its retirement plan audit activity. Two areas it is has been focusing on are: (1) whether responsible plan fiduciaries have been receiving and acting on the various disclosures provided by certain plan service providers under the DOL’s new covered service provider regulation; and (2) whether plan fiduciaries have been providing participants with the necessary disclosures required under the DOL’s new participant disclosure regulation.

Given the DOL’s focus on these two areas during audits, plan fiduciaries should be sure to:

  • Establish procedures to ensure that all required service provider disclosures are received, reviewed and cataloged.
  • Implement a formal review process at reasonable intervals to monitor the plan’s service providers and decide if it is prudent to continue using them or look for replacements.
  • Coordinate with the plan’s third party administrator and investment provider(s) to ensure that all required participant disclosures are timely made. Interim information updates are sometimes required in between annual disclosures (e.g., due to a plan amendment).

If you have questions about these issues or if you are interested in amending your retirement plan to allow Roth conversions, please contact any member of our Employee Benefits Practice Group:

Jeffery D. Kirtner

Craig A. Smith

This article provides general information and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. If you have specific legal questions, you are urged to consult with an attorney concerning your own situation.