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Roth 401(k)s to the rescue

By Jennie L. Phipps ·
Wednesday, January 2, 2013
Posted: 6 pm ET

The late-night "fiscal cliff" deal that cleared the U.S. Senate early on New Year's Day and was later approved by the House of Representatives partially pays for the cost of delaying budget cuts known as sequestration by allowing holders of 401(k) retirement accounts to convert some of their savings into Roth 401(k)s at any time.

Previously, holders of 401(k)s, 403(b)s and similar defined contribution plans could only convert in the wake of three qualifying events: a job change, retirement or reaching age 59 1/2. Under this deal, you no longer have these constraints.

If you convert to a Roth, you must pay income taxes owed on the money you have converted, but after that, you won't owe any more taxes on that money or on any gains. Bankrate's excellent primer compares Roth 401(k)s to conventional ones.

Why did Congress see this as an appealing strategy? The expectation is that many people in the wake of continuing uncertainty over taxes will see the prospect of being able to access their retirement savings without paying any further taxes on it as very appealing, flooding the U.S. Treasury with tax dollars resulting from conversions.

Assuming that your employer offers a Roth 401(k) -- many don't -- should you join the rush to convert? This change hasn't eliminated any of the retirement planning issues that might make you think twice about a Roth conversion. If you are close to retirement and you have reasons to think you'll pay significantly less income tax during retirement than you are paying during your working years, then you may find a Roth unappealing. It is particularly unattractive if it forces you to sell significant assets in order to pay the tax.

If you are younger and in a tax bracket where putting aside pretax money doesn't save you very much in current taxes, then converting to a Roth 401(k) is probably a great idea. By the time you are ready to retire, you could have a significant nest egg, all tax-free.

Everybody's situation is different. Particularly if you are not too far from retirement, get help before you make this decision. Unlike Roth individual retirement accounts, which can be re-characterized -- switched back to a conventional IRA -- these conversions are irrevocable. You can't change your mind.

Attorney, CPA and financial planner Leon LeBrecque concludes that for most people, "The Roth still makes sense. It's still a great tax-free investment vehicle."

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1 Comment
kevin copeland
January 03, 2013 at 11:22 am

For Chad/Fidelity inquiry on availability