Buried at the bottom of the Taxpayer Relief Act is a provision that allows more workers to convert their retirement savings into a Roth 401(k).
That is an appealing option to consumers who want some of their retirement savings to grow tax-free forever. And for the government, it is a revenue-raiser.
"It was thrown in to help pay for a lot of other things in the law," says Ed Slott, an IRA expert and certified public accountant whose website is www.irahelp.com. "It's like the golden goose." And it is expected to generate $12.1 billion in tax revenue over the next 10 years.
But even if workers would like to convert their traditional, tax-deferred 401(k) savings into a Roth 401(k) they may not be able to pay for the big upfront tax hit. "You'd have to have the dollars available to pay the taxes in the year you converted," says Laurie Nordquist, director of Wells Fargo Institutional Retirement and Trust. "That is a big hurdle for the Roth conversion."
And employees can only take advantage of the new rule if their 401(k) plan offers a Roth 401(k) option and allows the conversion. In 2011, 40 percent of 401(k) plans included Roth 401(k) accounts, according to a survey by Aon Hewitt. That has increased to 50 percent, based on a recent, informal survey of several hundred plan sponsors, says Rob Austin, retirement consultant at Aon Hewitt.
"They are realizing that it tends to be another form of diversification for the participants in their plan," he says. "In this case, it's a tax diversification."
Younger workers who expect their tax rate will be higher in retirement than it is now are most likely to take advantage of Roth contributions and conversions. A Wells Fargo study released in December found that 14.3 percent of Generation Y plan participants already contribute to a Roth 401(k), compared with 5.8 percent of Baby Boomers.
Although young workers have been able to make new contributions to a Roth 401(k), until now conversions were restricted to retirees or workers who were 59 and older. Only younger workers leaving a job could switch their 401(k) contributions into their own Roth IRA.
The new rule gives workers of all ages more flexibility. And those who can't afford to pay a big tax bill now can choose to do only a partial Roth 401(k) conversion. "You don't have to do all or nothing," Slott says.
Even older workers might want to switch some of their retirement savings into a Roth 401(k) if they worry that their tax burden will go up in the future. "There is no crystal ball," Austin says. "But if you put some money into the Roth and some into pretax savings, whichever way things come out, you are not bearing the full brunt of it."
Before that can happen, employers must decide if they want to add the feature to their plan. The Treasury Department is collecting questions they receive from employers and others, and is prepared to provide any guidance that is necessary.
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