As part of the American Taxpayer Relief Act (ATRA) signed by President Obama in early January, all 401k, 403b, and 457b retirement savings plans now have the option to allow participants to convert some or all of their pre-tax contributions (namely, pre-tax 401k deferrals, employer contributions, and rollovers) to after-tax Roth accounts.
A major goal of ATRA was to immediately increase federal revenue, and it is projected to generate about $12-billion in short-term revenue.
Converting pre-tax dollars to after-tax Roth dollars is a tax planning strategy for those who expect higher tax rates in the future:
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- When dollars are converted to after-tax amounts, they are taxable in the year of conversion, but they are later distributed tax-free.
- Also, future earnings on the converted balance are not taxed when distributed, provided they remain in the Roth account for at least five years and are received after age 59-1/2, death or disability.
Because each individual’s tax circumstance is different, converting to Roth might make sense for some, but not for others. Generally, those who expect their tax rate to increase should talk with their financial or tax advisor about the possibility of converting pre-tax dollars to Roth.
Certain aspects of the law, such as the distribution rules for newly converted balances, have yet to be clarified. There is plenty of time before year-end to get additional guidance from the IRS, so we recommend waiting until later in the year, when this guidance becomes available, before deciding on any conversions.
For the latest information on these and other details of the in-plan conversions, please call us at (312) 762-5960 or 