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Confusion Clouds 401(k)-to-Roth Conversions, Fidelity Survey Says

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Clients aren’t clear about new conversion rules, and need your help. More than half of investors who hold old 401(k)s with former employers aren’t clear whether those assets can be converted to Roth IRAs, according to findings from Fidelity Investments.

The survey of investors with retirement plan assets at former employers and annual household incomes of more than $100,000 showed that awareness of the Roth IRA conversion opportunity had increased over the past six months, but was still relatively low, with 35% of respondents aware of new tax rules that allowed investors at any income level to convert assets to a Roth IRA. That’s up from 12% from August 2009.

Investors’ knowledge of whether their 401(k) assets qualify for a Roth IRA conversion also has increased. Nearly half (45%) now say they know whether or not such assets can be converted to an IRA, up from 33% in 2009.

However, the Fidelity survey underscored a lack of understanding about Roth IRA conversion details that is keeping investors from rolling their workplace plan assets directly into Roth IRAs. When asked about the biggest barriers to converting, 33% said they do not understand the tax implications of converting to a Roth IRA and 22% are confused by the conversion process itself.

“The increase in awareness is promising, but there is still work to be done,” said Keri S. Dogan, senior vice president, Fidelity Investments. “Because a Roth IRA generally offers a number of potentially favorable benefits, such as the opportunity for tax-free growth and withdrawals, and no minimum required distributions, the conversion opportunity may be an option worth exploring for those newly eligible.”

Providing investors with basic information about Roth IRAs and the new conversion eligibility rules can help in that regard, the survey showed. Before being provided with any information, respondents were asked whether they had ever considered rolling 401(k) assets from a former employer to a Roth IRA. Only one-quarter (24%) initially said they had done so. Survey respondents were then given a detailed description of the benefits of a Roth IRA, including: the potential for earnings to grow federally tax-free, if certain conditions are met; the ability for contributions to be withdrawn penalty-free and tax-free at any time by the account holder or heirs; and the absence of required withdrawals at any age during the lifetime of the original owner. They also were given information about the January 2010 conversion eligibility changes. After receiving the information, nearly six in 10 (58%) said they would be likely to investigate converting their 401(k) with a former employer to a Roth IRA and 50% said they were considering rolling to one, but had not yet made a decision.

Since January 1, 2010, Fidelity said it has seen a “significant increase” in the number of Roth IRA conversions executed across its retail and advisor businesses. The volume of Roth IRA conversions at Fidelity in the first quarter of 2010 was four times the level experienced in the same period of 2009. Conversions to Roth IRAs directly from 401(k)s managed by Fidelity also increased, but represented a small percentage of the total conversions to date.