It used to be that you could not convert 401(k) assets to a Roth 401(k). But that's about to change, thanks to a new law that allows traditional 401(k) participants to convert at least part of their assets to a Roth 401(k). True, it will be in a more limited way than is currently available to IRA holders, provided their plans allow it, but it is now permissible. The conversion option is also available to 403(b) and 457 plan participants.

The Small Business Jobs and Credit Act of 2010 provides that, assuming the plan allows for it, employees can convert the portion of their 401(k) that consist of employer contributions into a Roth 401(k) if they meet one of the following criteria:

  1. they are age 59 1/2
  2. they have participated in the plan for at least five years
  3. the money has been in the plan for at least two years.

If the rollover is made this year, the participant could elect to pay the tax on the money in equal parts in 2011 and 2012. Once rolled over into the Roth 401(k) plan, the money would earn tax-free investment income and participants would not be taxed when they receive a distribution.

To convert, of course, your employer must offer the Roth 401(k) to begin with. While plans of all sizes can participate, the new provision was crafted with small-business owners in mind. But because adding a Roth choice will increase the cost of administering a retirement plan, small-business plan sponsors will have to determine whether the long-term benefit of withdrawing Roth funds tax-free (after paying income taxes on the amount converted) is worth the additional administrative expense.