In-Plan Roth Conversions Present Challenges

President Obama on Monday signed into law the Small Business Jobs Act, which included a provision allowing in-plan Roth conversions in 401(k), 403(b), and governmental 457(b) plans.

Jason Bortz, Partner, Davis & Harman LLC, says this presents a challenge for providers and sponsors as the provision is effective immediately. To offer the in-plan Roth conversion, the plan must offer a Roth account, and there is little time to do this in 2010, Bortz points out. Participants will benefit from having the in-plan conversion ability in 2010, because the bill allows them to spread the tax payment over 2011 and 2012; however, sponsors will have to implement a plan amendment and coordinate with their payroll systems, among other steps.

In addition, there are technical issues providers don’t have answers to and providers will struggle to implement the provision without clarification. For example, Bortz says a basic question is whether there should be income tax withholding at conversion or whether participants will pay taxes with their individual return.

The bill also allows for the first time Roth accounts within governmental 457(b) plans for tax years beginning after 2010, so those plan sponsors who want to offer Roth deferrals in their plan also have little time to get everything in place.

Though the in-plan conversion provision is somewhat advantageous to sponsors worried about high account balances leaving the plan and shrinking the plan, it doesn’t let participants do much more than what current law already allows, such as rollover accounts into a Roth IRA, Bortz notes. In-plan conversions still only apply to amounts distributable under the plan terms.
Bortz believes the legislation was mainly about nixing bias against plans. He points out that there is still a reason participants might prefer a conversion to an IRA, because with the IRA, a participant can change his or her mind and recharacterize their money as pre-tax at any time before taxes are due. They can’t do that with the in-plan conversion.Rebecca Moore