Over the years we have seen a lot of articles and received several calls about “backdoor Roths” or “Mega Roths”. Individuals who expect to pay higher taxes in the future or would like to avoid Required Minimum Distributions may want to consider converting their pre-tax monies to a Roth inside of their 401(k) or ERISA 403(b).
A Roth 401(k) in-plan conversion allows you to convert pre-tax monies into a designated Roth account within your 401(k) Plan. There are two types of in-plan conversions you have access to, provided certain conditions are met, and conversions are allowed by your plan: A Roth in-plan conversion involves taking monies in your 401(k) plan and converting it over to a Roth account within the same plan. Assets that qualify include your contributions, contributions from your employer, or assets rolled in from a former employer or IRA. An Expanded in-plan conversion allows for eligible vested plan balances to be rolled over to a designated Roth account even if those amounts are not currently available for withdrawal.
But aren’t there income limits that would disqualify me from a Roth 401(k)?
No, one of the advantages of a Roth 401k vs a Roth IRA is income limits do not apply. Those who do not qualify for a Roth IRA still qualify to contribute to a Roth 401(k).
Do I have to convert all assets to a Roth 401(k) if I decide to initiate the conversion?
No. The decision to convert non-Roth money to a Roth account within your plan is optional. You should consult your tax professional before moving forward. You can also convert a portion of your 401(k) contributions. For instance, you can convert just your employer contributions, and your pretax contributions may remain in a separate pre-tax bucket.
Can I withdraw the converted assets in the Roth 401(k)?
If you convert money to a Roth account that was already available for a withdrawal, this money will still be available to you immediately. However, if you convert money that was not available for a withdrawal, those assets will remain unavailable for a withdrawal, just as before the conversion. Remember the 5-year rule that requires assets to remain in the Roth to benefit from tax-free distributions for 5 years. Each conversion starts the 5-year clock. So, you may have previous Roth contributions and converted monies on two different 5-year schedules. You may also be subject to a 10% early withdrawal penalty if you make a withdrawal prior to reaching ag 59 ½.
Do I pay taxes on pre-tax contributions that I convert to a Roth 401(k)?
Yes. You have to pay taxes on both the base contribution and any earnings if you convert pretax contributions to a Roth 401(k) account. Check with your tax professional to see what tax liability you may incur.
Am I responsible for paying applicable taxes from a Roth in-plan conversion?
You must pay all taxes incurred as the result of a Roth in-plan conversion for the income tax year in which you made the conversion. Taxes incurred as a result of an in-plan conversion are not withheld from your payroll or converted contributions and you are responsible for the tax liability.
Will I receive a tax form if I move money to a Roth account?
Yes. An IRS Form 1099-R will be sent directly to the participant for the calendar year in which the conversion takes place.
In summary, converting pre-tax contributions can be a great tool and a big tax benefit for you in the future. Conversions also can help avoid RMDs for the portions of the monies converted to Roth. As always, each individual should consult their tax professional about their own individual tax situation.
Robert Kaplan, “Roth Conversions- Be Aware or Beware” NAPA July 14, 2021 https://www.napa-net.org/news-info/daily-news/roth-conversions%E2%80%94be-aware-or-beware
Fidelity, 2014 “Frequently asked questions about Roth 401(k) contributions, after-tax contributions, and the Roth in-plan conversion feature”