In-plan conversions to Roth accounts, part 2 of 2

Most in-plan conversions will be taxable in the year they are rolled over, so employees may want to convert half of the desired amount in 2011 and the other half in 2012, thereby spreading the tax over two years. However, unlike converting from a traditional IRA to a Roth IRA, the decision cannot be rescinded, even within the tax year that the conversion decision was made. And, the converted amount is eligible for a 10% penalty tax if a withdrawal is made within five years and the participant is under age 59 ½.  The five-year timing begins upon conversion of funds to a Roth account.

Choosing to convert funds in a 401(k), 403(b) or 457(b) account is typically treated as a distribution, but there are some exceptions:

  • A plan loan can be transferred without changing the repayment schedule or treating the loan as a new loan.
  • Married plan participants are not required to obtain spousal consent to convert a plan account to a Roth account.
  • An accrued benefit in excess of $5,000 is not automatically triggered. The participant has the right to defer receipt.
  • A distribution right is not triggered with an in-plan Roth rollover.

Remember that employers are responsible for preparing Form 1099-R for each year that an in-plan conversion occurs for an employee.

Complete details of the IRS ruling can be found in Notice 2010-84.