Tax change gives 401(k) savers a new opportunity
Uncle Sam's plan to raise more revenue opens up a retirement savings opportunity for some workers.
A provision tucked into the American Taxpayer Relief Act of 2012, which President Obama signed into law this month, allows more employees to convert funds from a traditional 401(k) to a Roth 401(k).
Before, employees could transfer money from a traditional 401(k) to a Roth 401(k) only if certain conditions were met.
Now the only conditions to be eligible are that your employer must offer a Roth 401(k) and offer the option to convert.
About 40 percent of midsize and large employers have the Roth 401(k), said Alison Borland, vice president of retirement solutions and strategies at consulting firm Aon Hewitt.
A Roth 401(k) is an employer-sponsored retirement savings account that's funded with after-tax money, meaning you pay the tax now on the money you put aside. After you reach age 59 1⁄2, withdrawals of any money from the account — including investment gains— are tax-free.
In contrast, a regular 401(k) is funded with pretax money, and you pay the tax when you make withdrawals.
So when you convert a traditional 401(k) to a Roth 401(k), you pay tax now on the amount in the account, just as you would if you converted a traditional IRA into a Roth IRA.
“It's changing the tax treatment of their account from paying later to paying now,” Borland said.
Given the benefits of Roth plans, I wouldn't be surprised if more employees took advantage of a Roth 401(k).
The Roth 401(k) has no income limitations for those who want to participate, unlike a Roth IRA. Anyone, no matter what income level, is allowed to invest up to the contribution limit into the plan.
But give it lots of thought before deciding to convert your plan.
“The decision to convert is highly complicated and depends on your time horizon for distributions, and your guess as to future tax rates and rates of growth and inflation,” said Ronnie C. McClure, a certified public accountant in Lewisville, Texas.
Experts say a Roth 401(k) is best suited for those who think they will be in a higher tax bracket in retirement than they are now.
“It's good for some people,” Borland said. “The reason you'd want to pay tax now instead of paying it later is if you think you'd pay less tax now. If you think you're going to be in a lower tax bracket today than you are when you retire, a Roth might be a really good idea for you.”
On the other hand, “if you're already in a very high earnings place with a high tax rate and you expect that will go down when you retire, then a Roth would not be a good option for you,” she said.
Consult a tax adviser before you decide whether to convert to a Roth 401(k).
“We encourage participants to evaluate their tax strategy when considering a Roth conversion, and recommend that participants have funds outside of their 401(k) savings to cover the tax liability associated with the conversion,” said Donna Norwood, senior vice president at Fidelity Investments. “Furthermore, a participant must be cognizant of whether the income related to the conversion may push them into the higher tax rates as set forth in the new law.”
The Roth 401(k) provision may encourage more companies to offer such an account.
“First, it may encourage plan sponsors who have not done so to implement a Roth feature in their plan,” Norwood said. “Second, it permits participants in authorizing plans to diversify savings amounts in their accounts that are invested on both a pretax and post-tax basis, and we feel this type of investment diversification may be just as important as diversifying across asset classes.”
No matter what you decide to do - with the help of your tax adviser - this is too good an opportunity not to explore.
Show commenting policy
TribLive commenting policy
You are solely responsible for your comments and by using TribLive.com you agree to our Terms of Service.
We moderate comments. Our goal is to provide substantive commentary for a general readership. By screening submissions, we provide a space where readers can share intelligent and informed commentary that enhances the quality of our news and information.
While most comments will be posted if they are on-topic and not abusive, moderating decisions are subjective. We will make them as carefully and consistently as we can. Because of the volume of reader comments, we cannot review individual moderation decisions with readers.
We value thoughtful comments representing a range of views that make their point quickly and politely. We make an effort to protect discussions from repeated comments either by the same reader or different readers.
We follow the same standards for taste as the daily newspaper. A few things we won't tolerate: personal attacks, obscenity, vulgarity, profanity (including expletives and letters followed by dashes), commercial promotion, impersonations, incoherence, proselytizing and SHOUTING. Don't include URLs to Web sites.
We do not edit comments. They are either approved or deleted. We reserve the right to edit a comment that is quoted or excerpted in an article. In this case, we may fix spelling and punctuation.
We welcome strong opinions and criticism of our work, but we don't want comments to become bogged down with discussions of our policies and we will moderate accordingly.
We appreciate it when readers and people quoted in articles or blog posts point out errors of fact or emphasis and will investigate all assertions. But these suggestions should be sent via e-mail. To avoid distracting other readers, we won't publish comments that suggest a correction. Instead, corrections will be made in a blog post or in an article.
- Wolf reverses Corbett, says deal between Highmark, UPMC doesn’t limit continuity of care to very ill
- Unemployment rate continues to drop as U.S. adds 295K jobs
- Big banks’ levels of capital strong, Federal Reserve finds
- IPO might test Etsy’s approach to commerce
- Researchers: U.S. lacks proving ground for nuclear energy innovations
- Americans see improved job market but a vulnerable economy, Pew poll finds
- Race toward bigger phones eases
- AbbVie to buy leukemia drugmaker Pharmacyclics for $21 billion
- Worker productivity falls faster than estimated; labor costs rise
- Stocks snap losing streak as ECB reveals stimulus start date
- Impact fees garner support from state community leaders