More On Tax Planningfrom The Advisor's Professional Library
- Annuities: Variable Annuities Annuities are hot. The tax rules vary with the circumstances. Advisors must be aware of these intricacies when discussing annuities with clients.
- Annuities: Estate Tax The value of certain types of annuities may be included in an estate’s value. Understanding the intricacies of these inclusions is a critically important aspect of estate planning.
The budget legislation allows 401(k) participants to convert any amount of money in their plan to a Roth 401(k), if such a plan is offered by their employer. The money, taxed at the time of conversion, can then be withdrawn tax-free at the time of retirement. The Joint Committee on Taxation estimates $12 billion in revenue will be raised by 2022 as a result.
Bloomberg reports the conversion opportunity “can benefit people with significant balances, the up-front money to pay taxes now with funds outside their retirement account and years of tax-free earnings ahead of them or their heirs. Conversions to Roth 401(k)s had been limited to certain funds and to plans that allowed the switches. The law opens the opportunity to more workers who hold $5 trillion in employer-sponsored defined contribution plans including 401(k)s.”
Michael Kitces, director of financial planning with Pinnacle Advisory Group in Columbia, Md, and AdvisorOne contributor, wrote in his blog on Jan. 1, “The reason this provision is notable is that, under current law, you can only convert a 401(k) plan if you are eligible to take a distribution from the plan (whether it's going to a Roth 401(k) or Roth IRA), which generally means you have to be 59 1/2, dead, disabled, or separated from service, unless the plan allows in-service withdrawals.
“The new ATRA provision will allow an intra-plan Roth conversion, regardless of whether you're eligible for a distribution out of the plan (the way you would have to be to get to a Roth IRA). Notably, the rules appear to allow the new intra-plan Roth conversions for 401(k), 403(b), and 457 plans.”
Basically, he continues, the new rule simply means a plan participant can now do intra-plan 401(k) (or 403(b) or 457 plan) conversions from traditional to Roth in the same manner you can do so for IRAs.
“But you still can't go from a 401(k) (or other employer retirement plan) to the IRA unless you're otherwise eligible for a distribution from the retirement plan,” he cautions. “In theory, the increased flexibility for Roth conversions means more (current workers) will convert their existing 401(k) and other employer retirement plans, which provides a short-term revenue increase for the Federal government (thus, this new rule was actually scored as a ‘revenue raiser’ in measuring the fiscal impact of the provision). Of course, as I've written in the past, whether completing a Roth conversion (inside a 401(k) or with an IRA) is a good deal or not depends on several individual-specific factors.”
Bloomberg notes that Americans held $5 trillion in defined contribution plans as of Sept. 30, including $3.5 trillion in 401(k)s, according to the Washington-based Investment Company Institute.
“We absolutely see this as a positive,” says Judy Miller, ASPPA’s director of retirement policy. “We lobbied for in-plan transfers for amounts that are distributable, so this was a pleasant surprise and we can now strike it from the list for this year. We felt it was always important to level the playing field between IRAs and 401(k)s. This is especially true when to comes to small businesses, who often would have to terminate the plan to get at that money.”
In addition to small businesses, Miller says the legislation will benefit a wide array of workers, but they would have to be able to handle the tax burden in the year they convert. Since there would be little or no tax liability for workers who are just beginning to save, they would benefit, on particular.