The American Taxpayer Relief Act of 2012 (the “Act”), signed into law by the President on January 2, 2013, expands the availability of in-plan Roth conversions in retirement plans. The new rules apply to conversions made after 2012.
Background. Prior to the Act, 401(k), 403(b) and governmental 457(b) plans could accept after-tax Roth contributions. Further, participants in those plans could convert vested non-Roth amounts-such as pre-tax elective deferrals- held in their plan accounts to after-tax Roth amounts, by making a taxable in-plan Roth conversion. Although the conversion is taxable when made, the 10% penalty on early withdrawals generally does not apply to the conversion. Also, if certain conditions are met, subsequent distributions of the amounts converted and the earnings thereon could be made tax-free. However, pre-Act in-plan Roth conversions were limited to amounts that are otherwise distributable and eligible for roll over under the Internal Revenue Code (the “Code”).
Distributable/Eligible For Rollover. Under the Code, vested non-Roth amounts which are distributable and eligible for rollover, and thus could be converted to Roth amounts prior to the Act, include:
–pre-tax elective deferrals (and related earnings) in a 401(k) or 403(b) plan after the participant reaches age 59½, severs employment, dies or becomes disabled;
–pre-tax elective deferrals (but not related earnings) in a 401(k) or (non custodial account) 403(b) plan while the participant is in-service, before the participant reaches age 591/2 and after the participant incurs a hardship;
–vested non elective employer contributions (and related earnings) in a 401(k) or (non custodial account) 403(b) plan after the participant severs employment, becomes disabled, reaches a specified age or participates in the plan for a stated period of time;
–vested contributions (and related earnings) in a custodial account 403(b) plan after the participant has a severance from employment, dies, becomes disabled, or attains age 59 ½;
–vested deferred amounts in a government 457(f) plan after the participant has a severance from employment, an unforeseeable emergency or reaches age 70 ½; and
–any amounts that had been rolled over to a 401(k) or 403(b) plan (and related earnings).
The Act. Under the Act, 401(k), 403(b) and governmental 457(b) plans may (but need not) allow participants to make the taxable in-plan Roth conversion described above, whether or not the amounts to be converted are otherwise distributable or eligible for rollover under the Code. The elimination of the distributable/rollover requirement should greatly expand the amounts that may be converted. To permit these conversions, the plan will have to allow on-going Roth contributions, and will have to be amended to reflect the availability of the conversions, probably by the end of calendar year 2013.