Have you heard of The American Workers, State and Business Relief Bill of 2010 that’s been floating through Congress this year? Don’t worry, you’re not alone. It hasn’t received much press, but there was one little tidbit that caught my attention since it has to do with Roth 401(k)s and conversions. The idea is to make it easier for 401(k) plan participants to be able to convert their pre-tax contributions to a Roth 401(k) within their existing plan. Sounds good, right?
The bill would authorize a 401(k) plan to allow plan participants experiencing a distributable event to directly roll over the distribution to a Roth 401(k) account maintained under the 401(k) plan for the benefit of the individual to whom the distribution is made. The provision would effectively keep the participant’s money in the plan, thereby potentially reducing “leakage” from the participant’s account.
You Still Need a Distributable Event
This is where the bill falls flat. In order to take advantage of a Roth conversion you still need a distributable event. This means you need to terminate employment, retire, and so on before you can do this. The problem is that these distributable events already allow you take your money out of the plan and do what you want with it, either roll it into a Traditional IRA, convert to a Roth IRA, cash some out, etc.
Usually when people have a distributable event the first thing they want to do is roll over their 401(k) so they can take more control over their money. All this bill is doing is making it easier for someone with a distributable event to obtain Roth status by keeping the funds with the 401(k) provider. How does this help the investor? Seems to me it’s only helping the plan providers and fund companies by making it easier for them to retain assets.
Not Many Plans Will Be Able to Take Advantage
Finally, according to the bill this Roth conversion provision is going to basically be limited to 401(k)s that already have a Roth account. I don’t know the stats, but I’m fairly certain that Roth 401(k)s are quite uncommon as it is, so the vast majority of people will not have access to this new rule.
A plan that does not otherwise maintain a designated Roth program may not establish a designated Roth account solely to accept rollover contributions. The distribution to be rolled over to the Roth 401(k) must be otherwise allowed under the plan. Thus, distributions subject to restriction (i.e., in-service distributions and other pre-retirement age distributions) may not be rolled over to the Roth account.
A plan must be amended (within a prescribed remedial amendment period) in order to allow for the rollover of 401(k) funds to the Roth 401(k). However, a 401(k) plan that includes a Roth program is not required to allow employees (and surviving spouses) to execute the Roth conversion.
If I understand this correctly, the bill says the conversions are only allowed by 401(k) plans that have an existing Roth account option, and even if they do they are not required to allow the conversion. I have to wonder just how many plans are even going to be bothered with the trouble of amending their plan to take advantage of the changes.
So, What’s the Point?
When I see legislation like this I have to just scratch my head and wonder what the point of it is. If you’re selling it as a way to help investors and give them more opportunities to take advantage of the tax-free benefits of a Roth why is it so limited that hardly anyone will actually be able to do it? Not only that, but why limit it to distributable events and actually create a mechanism for fund companies and plan sponsors to retain assets instead? That’s not helping investors, but the already expensive funds that are making a lot off of the fees participants are paying.
So, what’s your take on this? Does this Roth conversion part of the bill have any merit or is it all just fluff?
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.