Q. My company recently announced that they are allowing what they are calling an “in plan conversion,” which will allow employees the ability to convert pre-tax retirement contributions to a Roth-type of account. I am interested in this because my AGI is too high to allow for any contributions to a Roth IRA. I have read that if the market value of a Roth conversion declines, you have a certain period of time in which to undo the conversion. Is this true for this type of conversion?
Under the American Taxpayer Relief Act of 2012, an in-plan Roth conversion may be made as a transfer as of Jan. 1, 2013. Prior to this new provision, there needed to be a distributable event for pre-tax contributions to be moved into a Roth account with the same plan, and this was technically a rollover. Amounts in non-Roth accounts can now be converted by transfer. The law now allows this, but employers do not have to provide this option. As with any Roth conversion, income taxes must be paid on the amount converted in the year the conversion occurs. Since the funds transferred from a pre-tax to a Roth account are not distributed from the plan, the income taxes due as a result of the conversion must be paid from other assets.
One of the forgiving rules about Roth IRA conversions is the ability to recharacterize (undo) the conversion back to an IRA. If you convert an IRA this year, you will have until Oct. 15, 2014, to initiate and complete a recharacterization. If you recharacterize, any tax liability associated with the conversion is removed, and taxes paid due to the conversion will be refunded. The rules for an in-plan Roth conversion do not permit you to recharacterize. That’s it; once the money is moved, it remains a Roth account. There is no turning back if you change your mind because the value has declined, you realize you don’t have the money to pay the tax owed, or for any other reason.
There may be better options for you than making an in-plan transfer. In-plan transfers and rollovers are permitted only when the plan contains or is amended to provide a Roth elective deferral feature. A plan cannot simply allow for Roth rollovers or transfers. Since your plan is allowing the new transfer option, you must have the ability to make elective contributions to a Roth account. Switching your elective contributions from pre-tax to a post-tax Roth account may be a better idea than making a transfer. If you have a pre-tax IRA, regular Roth conversions for a small portion of the IRA made over a number of years is another idea that may be better for your situation. If you don’t have any pre-tax IRA or if they are small, making a non-deductible IRA contribution and immediately converting it to a Roth IRA may be another option.
A meeting with a knowledgeable tax or financial professional may be prudent.
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624