What Is a Roth In-Plan Conversion and How Does It Work?

Understanding In-Plan Roth Conversions

An in-plan Roth conversion allows individuals to transfer pre-tax money held in an employer-sponsored retirement plan, such as a traditional 401(k), 403(b), or 457(b), into a Roth account within the same plan. Instead of growing tax-deferred and being taxed upon withdrawal in retirement, the converted funds become part of a Roth account where qualified distributions in retirement can be entirely tax-free.

By converting pre-tax funds to Roth now, participants pay taxes on the converted amount in the present, aiming for tax-free withdrawals during retirement. This can be particularly beneficial if one anticipates being in a higher income tax bracket in the future or if current tax rates are perceived as relatively low.

An in-plan Roth conversion is distinct from a Roth IRA conversion, which involves moving funds from a workplace plan or traditional IRA to a Roth IRA held outside the employer plan. It also differs from a direct rollover, where funds might be moved from one pre-tax account to another pre-tax account in a different plan or IRA. The key characteristic of an in-plan conversion is that the assets remain within the existing employer-sponsored retirement plan, simply shifting from a pre-tax status to an after-tax Roth status.

Eligibility and Plan Considerations

Not all employer-sponsored retirement plans offer the option for an in-plan Roth conversion. The availability of this feature depends entirely on the specific provisions outlined in the employer’s plan document. Individuals considering this move must verify that their particular plan allows for in-plan Roth conversions.

Beyond plan availability, eligibility criteria apply to the individual participant. Funds must be vested, meaning the participant has full ownership of their contributions and any employer contributions, before they can be converted. Common account types eligible for conversion include pre-tax employee deferrals and employer contributions held in traditional 401(k), 403(b), or 457(b) accounts. Participants should consult their plan administrator or review their plan’s summary plan description for specific requirements.

If the option is available, the plan administrator or recordkeeper will have established procedures for initiating the conversion.

Taxation of Converted Amounts

The primary tax consequence of an in-plan Roth conversion is that the converted amount is generally taxable as ordinary income in the year the conversion occurs. This means the entire pre-tax portion of the converted funds, including both original contributions and any accumulated earnings, is added to the individual’s gross income for that tax year. This immediate tax liability is the trade-off for potentially tax-free withdrawals in retirement. The individual is responsible for paying taxes on this additional income at their marginal tax rate.

The plan administrator or recordkeeper is responsible for reporting the converted amount to the Internal Revenue Service (IRS). This reporting is typically done on Form 1099-R. The individual will receive a copy of this form, which must be used when filing their federal income tax return for the year of the conversion. It is important to account for this increased taxable income when planning for the tax year.

If an individual has made after-tax contributions to their traditional retirement plan, those specific amounts are not subject to tax upon conversion to a Roth account. This is because taxes have already been paid on these contributions. Only the pre-tax contributions and their associated earnings, which have not yet been taxed, become taxable upon conversion. This distinction is important for accurate tax calculation and should be clearly identified by the plan administrator.

For distributions from the Roth portion of the plan to be considered “qualified” and therefore tax-free and penalty-free, two main conditions must be satisfied.

• First, the distribution must occur after the five-year period beginning on January 1 of the calendar year in which the first contribution or conversion was made to any Roth account within the plan.
• Second, the distribution must be made after the account owner reaches age 59½, becomes disabled, or dies.

Meeting these criteria ensures that the future withdrawals benefit from the tax-free status.

Performing the Conversion

Initiating an in-plan Roth conversion typically begins by contacting the employer’s retirement plan administrator or the plan’s recordkeeper. Many plan providers offer dedicated online portals or specific forms designed to facilitate this process. These resources usually guide participants through the necessary steps and provide detailed instructions.

During the conversion process, individuals will generally be prompted to specify the amount they wish to convert from their eligible pre-tax balance. This could involve converting a partial amount or the entire available balance. It is prudent to carefully consider the amount, as the converted sum will be immediately taxable. Understanding any potential impact on future contributions or existing investment allocations within the plan is also important.

Once the conversion request is submitted, the plan administrator will process the transaction according to the plan’s established procedures. Following the successful completion of the conversion, participants should receive a confirmation statement. This document will typically detail the exact amount converted, the date of the conversion, and the updated balances in both the traditional and Roth portions of their retirement account.

After the conversion, subsequent account statements will reflect the newly established or increased Roth balance within the plan. For tax purposes, the converted amount will be reported by the plan administrator to the IRS, and the individual will receive Form 1099-R in the subsequent tax year. It is highly recommended to retain all documentation related to the conversion for personal tax records.