Less attention was paid to the question of converting a traditional 401(k) to a Roth 401(k) -- mainly because no mechanism existed to enable such a conversion until September 2010, when President Barack Obama signed a bill allowing conversions within workplace retirement plans.
So now the question is: Should you convert your 401(k) or 403(b) plan to a Roth?
In the first place, your employer plan must include a Roth 401(k) or Roth 403(b) option. Many still do not. And separately, your plan must allow such a conversion.
Popularity of Roth 401(k)s
Roth 401(k)s have been growing in popularity since the Pension Protection Act of 2006 granted them permanent status (originally they were set to expire in December 2010).
Still, they're not exactly ubiquitous. A study released last fall by Hewitt Associates found that 29 percent of mid- to large-size companies offered it to their employees, though 25 percent more indicated they were likely to add it.
Fewer companies allow a conversion. A November 2010 survey from Mercer, a human resource consultant group, found that only 17 percent of plan sponsors were allowing Roth 401(k) conversions in 2010, though 14 percent said they would add the conversion feature in 2011.
But many employers -- 45 percent -- have no plans to implement the changes.
That may be because many employees don't take advantage of a Roth 401(k) option even if their employer offers it, says Amy Reynolds, a partner in Mercer's retirement, risk and finance business.
It's true. In the Hewitt study, 4 percent to 22 percent of plan participants with access to a Roth elected to invest in it.
"If you have low numbers using the Roth option, do you want to go to the trouble of adding the Roth conversion?" Reynolds asks.
Besides getting employers onboard with offering Roth 401(k) conversions, a few other hurdles stand between workers and what the Internal Revenue Service calls an in-plan Roth 401(k) rollover.
Requirements for conversion
Three requirements must be met before employees can convert their 401(k) accounts to Roth 401(k)s.
- The plan must offer all workers the option of making Roth contributions.
- The plan must allow Roth 401(k) conversions.
- The contributions to be converted must be eligible for distribution.
The third requirement bears further explanation.
To qualify for a penalty-free distribution, employees must be old enough or changing jobs or disabled or dead. The latter two conditions would be tough to meet for this purpose, but the age requirement is the stickler: Participants must be age 59½ before they can convert to a Roth 401(k).
Employer contributions, in the form of employer matches and profit-sharing contributions, may be converted before the participant reaches retirement age, however.
"The plan could permit you to convert that money once it's vested -- if it has been in the plan for two years or if you've been a participant for five years," says Judy Miller, chief of actuarial issues and director of retirement policy for the American Society of Pension Professionals and Actuaries.
Remember that plan rules vary from employer to employer. The IRS guidelines may be more lenient than what is permitted by your plan.