The option for in-plan conversions from traditional 401(k) accounts to a Roth-style version may seem complicated, but it’s increasingly a smart choice for your customers to offer their employees. “Employees saving for retirement in workplace 401(k) plans are increasingly choosing the Roth option,” Ashlea Ebeling writes for Forbes.com, citing Aon Hewitt’s 2014 Universe Benchmarks report. “When the Roth option is available, 11 percent of participants contribute to a Roth, up from 9.6 percent in 2012.”
The American Taxpayer Relief Act, which became effective in 2013, allows the conversion of vested money in a traditional 401(k) into a Roth-style account. It also allows for converting part of an account, to help with the tax implications, Ebeling writes for a different Forbes.com story. An in-plan conversion can be a powerful move for your clients’ employees, but only those in certain situations will benefit.
Those groups include what Ebeling calls “high-net-worth individuals who don’t need all the money in their 401(k) for retirement expenses but want to grow it as an income-tax-free inheritance for their spouse or kids.” These conversions can also benefit young workers in low tax brackets who have plenty of time for that money to grow tax-free before retirement.
Employees converting their plans likely face high-income tax costs, so high-net-worth individuals who see extreme losses or gains in various years should pay careful attention to timing their conversions, Andrea Davis writes for Employee Benefits Adviser. Davis also includes a warning: the rules concerning taxation and other aspects of traditional vs. Roth accounts are subject to political agendas and priorities. “You’re making a deal with a partner that has a very poor track record of keeping its promises,” Davis writes, quoting Anton Bayer, CEO of Up Capital Management. ”Ten, 15 years from now, you don’t know who’s going to be in Congress, who’s going to be the president and what the tax law will be.”
So, how can you help your clients decide to offer conversions and educate their employees?
First, let them know about the relatively low cost, writes Robert Lawton for Employee Benefits Adviser. It involves amending plans to add the conversion feature, and then spreading the word among participants. “Depending upon the size of the plan, the total cost of a plan amendment and communication materials falls somewhere between $2,500 and $5,000,” he writes. He also advocates for helping employees understand that converting even a small amount into a Roth-style plan can pay off in the future. These plans must exist at least five years before amounts can be withdrawn tax-free, so starting an account with a minimal investment keeps employees’ options open. “There appears to be no downside associated with adding a Roth in-plan conversion feature. It will not cost anything additional to administer each year and is a nice option to offer employees,” Lawton writes.