This entry is the second of a two-part series covering in-plan conversions to the increasingly popular Roth option.
In Part 1, I cited a recent Aon Hewitt survey indicating many employers are considering adding a Roth option to their retirement plans. In this second part, I’ll explore who might want to consider taking advantage of this conversion opportunity.
Conversion basics
- Roth 401(k)s are relatively new, with only about half of employers currently offering them, although the number is rising. Less than 20% of employees who have been offered Roth 401(k) accounts have one.
- The strategy is much like converting a traditional pretax IRA to a Roth IRA, a move some taxpayers make if they think it’s worth paying taxes at today’s historically low rates rather than later.
- You pay income tax on the amount you convert — the 10% early withdrawal penalty doesn’t apply to the conversion amount.
- The Roth grows tax free, and qualified distributions are tax free.
- The new rules became effective Jan. 1, 2013, but you can transfer amounts contributed to pretax accounts in 2012 and earlier.
- A Roth conversion may make sense if you expect your tax rate to be the same or higher in retirement, and you won’t need the funds for a decade or more.
- In general, the ability to convert is more beneficial to younger savers years from retirement because they have a longer time to recoup the amount paid in current taxes.
Conversion considerations
- Evaluate the costs versus the anticipated benefits. For example, balance lost future earnings from the cash you’d use to pay the current income taxes against the present value of the amount of future taxes you anticipate saving.
- Ask yourself whether you have money outside the plan to pay income taxes associated with the conversion. It’s generally considered much less desirable to pay the taxes from the conversion amount.
- If you’re worried about the size of the tax bill involved, or about potentially bumping yourself into a higher bracket, consider a partial conversion — a smaller amount or a series of smaller amounts for a number of years.
Some financial professionals recommend having your savings split up among tax-free, tax-deferred and taxable vehicles for added flexibility in tax and distribution planning. But conversions and rollovers can be complex, so consult your financial advisor for guidance about whether an in-plan Roth 401(k) conversion may be a good choice for you.
Any opinions expressed are solely the opinions of Jon Vogler and do not necessarily reflect the opinions of Invesco Distributors, Inc. or any of its affiliates. This information is not intended as tax advice. Please consult a tax advisor regarding individual situations.
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