In the last week of September, Congress passed and President Obama signed into law the Small Business Jobs Act of 2010. The SBJA includes a provision that permits most 401(k) plan sponsors to allow eligiple plan participants to make an “In-Plan Roth Rollover”1 of all or a portion of their pre-tax accounts, effective immediately. (Note: a plan amendment would be required.)
By an In-Plan Roth Rollover, an individual participating in an employer-sponsored 401(k), profit sharing or stock bonus plan (including a former employee), regardless of compensation level, could convert all or a portion of his or her pre-tax 401(k) deferrals, employer matching contributions, employer profit sharing contributions, and the earnings on all such contributions to an after-tax account under the plan. (It’s called a “Rollover” but the funds never leave the plan.)
Among the potential advantages of an In-Plan Roth Rollover for a participant/taxpayer are the following:
1. The eventual distribution of the participant/taxpayer’s In-Plan Rollover Account will be free from income tax (including future earnings on the Account).
2. Participant/taxpayers can accelerate income into 2010, when lower tax rates may still apply.
3. For In-Plan Roth Rollovers occurring in 2010, the a participant/taxpayer will have the choice between (a) recognizing the full amount of the Rollover as ordinary income in 2010, or (b) recognizing the amount of the Rollover as ordinary income in two equal installments, in 2011 and 2012 (and paying the taxes on his/her returns filed for those years). The participant/taxpayer does not need to make the decision as to whether to recognize all of the income in 2010, or split it, until the time the participant/taxpayer actually files his/her tax return, including extensions, for the 2010 year.
4. By paying the income taxes due on the Rollover amount with assets held outside the retirement plan, as the law permits, the participant/taxpayer can preserve the full amount of the Rollover in the plan, which will continue to accumulate tax-free.
5. In-Plan Rollover Accounts continue to enjoy the absolute protection from creditors that applies to all qualified plan accounts.
A five-year holding period applies to the Rollover Account, and an amendment of the employer’s qualified 401(k), profit sharing or stock bonus plan most likely will be required. Additionally, the Internal Revenue Code places many requirements and some limitations on these conversions (e.g., only the amount that could be withdrawn by or distributed to a participant may be rolled into a Roth Account), so don’t try this at home. However, most employers and executives will want to contact their human resources and or legal departments (or outside counsel, hint, hint) to get this process started.