On Monday, President Obama signed into law the Small Business Jobs Act of 2010 (“SBJA”). The bill contains a provision which would permit Code Section 401(k), 403(b) and, beginning on January 1, 2011, 457 plan participants to rollover, or essentially convert certain balances within their retirement plan accounts to Roth contributions within the same employer-sponsored retirement plan. This change in law continues the path of permitting more flexibility for participants with respect to retirement plan savings. Previously, the Worker, Retiree, and Employer Recovery Act of 2008 (“WRERA”) had removed certain income and filing restrictions on participants making an eligible rollover distribution after January 1, 2010, from balances within an employer-sponsored 401(k) or 403(b) plan to a Roth IRA outside of the plan. Now, the SBJA allows participants even greater flexibility with respect to conversion of pre-tax retirement balances to Roth balances by allowing such balances to be converted and yet remain within the same tax-qualified employer-sponsored plan.
The amounts which now may be converted into Roth contributions are those funds within a participant’s account that may be distributed in the form of an eligible rollover distribution. Generally, and depending upon the terms of a plan, salary deferrals available for in-service distributions (i.e., salary deferrals of a participant who has attained age 59-1/2), and other forms of contributions within a plan for which the in-service distribution requirements of the plan have been met qualify to be an eligible rollover distribution, and therefore are funds that may be converted into Roth contributions under the new law. In order to take advantage of this new conversion feature, a plan must permit Roth contributions, must allow in-service distributions of the amounts to be converted, and must be amended to allow for such Roth conversions.
The conversion or eligible rollover distribution of the amounts would be a taxable event for the participant. However, for conversions occurring during 2010, the SBJA allows a participant to include the converted amount in income, ratably over the two-year period of the 2011 and 2012 tax years. Alternatively, the participant may elect to recognize the full amount of the conversion in income for the 2010 tax year. Any such election must be made by the due date of the participant’s tax return for the 2010 tax year (the law does not indicate whether this deadline will be extended where a participant receives an extension for filing his or her 2010 tax returns). For conversions occurring in tax years subsequent to 2010, the converted amount would be included in income during the year of conversion. The 10% early withdrawal penalty charged on early withdrawals from a tax-qualified plan does not apply to a conversion to Roth contributions.
Participants may be interested in taking advantage of such conversion in order to diversify their tax positions in retirement. When distributed in retirement, Roth contributions and the earnings thereon will be distributed tax-free if certain requirements are satisfied, compared to traditional elective salary deferral and other forms of non-Roth contributions (and earnings on such contributions), which will be taxed upon distribution.
What to do now
The conversion provisions of the Small Business Jobs Act took effect immediately upon the bill becoming law. Therefore, any plan sponsor who wants to add the feature in 2010 so that plan participants could take advantage of the conversion feature in 2010 in order to recognize the resulting taxable income ratably between the 2011 and 2012 plan years must act quickly.
Specifically, plan sponsors interested in adopting this feature into their 401(k) or 403(b) plans during 2010 should ensure that their plans permit Roth contributions, and should:
- Contact the plan’s third-party administrator, as soon as possible, to verify the TPA’s capability to administer the provision during 2010;
- Communicate the change to plan participants, as soon as possible, allowing eligible participants the opportunity to consider and, if desired, to make a conversion or rollover contribution during 2010; and
- Amend the plan to permit eligible rollover distributions of non-Roth contributions into a designated Roth account.