Roth Conversions

Art by Melinda Beck

Roth defined contribution (DC) retirement plan accounts have seen a surge in interest, especially with retirement plan sponsors, since their introduction in 2001.

According the 2017 PLANSPONSOR Defined Contribution (DC) Survey, 68.5% of plan sponsors offered Roth accounts last year, compared with 52.4% in 2013.

The IRS issued guidance in 2010 allowing for participants to do an in-plan rollover, called a conversion, of pretax accounts to Roth accounts upon a distributable event. But in 2012, it expanded that ability to nondistributable amounts. The 2017 survey found that 41.2% of plan sponsors offered an in-plan Roth conversion.

“A Roth conversion involves taking assets that have been contributed on a pre-tax basis and, just like it sounds, converting them into Roth dollars,” says Meghan Murphy, vice president of Fidelity Investments. “But, in the process, that means you have to pay taxes within the year that you complete the conversion on that dollar amount.”

Participants can opt to convert their entire pretax balance or a portion of it. According to Murphy, most participants will choose a specific dollar amount, in order to diversify their taxes in retirement.

Additionally, Jana Steele, senior vice president and defined contribution consultant at Callan Associates, says taxes can play a part in considering the amount of money to convert. “If you’re going to convert your entire balance, depending on what that balance is, [taxes] can be a significant amount,” she says.

Once participants complete a conversion, they are issued a record of the amount to be included as income for that year, says Murphy. Going forward, dollars converted will be treated as Roth dollars in any earnings on that money, and, as long as the cash remains invested for five years, it will stay tax-free for retirement