A provision within the Small Business Jobs and Credit Act of 2010 passed by the House Thursday will allow participants in 401(k), 403(b), and 457 tax deferred plans to convert those savings into a Roth IRA account if employers sponsor a Roth IRA in their plan, potentially increasing the number of people who will take advantage of Roth conversions.
The provision will take effect as soon as President Barack Obama signs it into law, which he is expected to do by the end of this month.
Changes to Roth IRA rules made earlier in the year also have increased the number of taxpayers likely to choose a Roth IRA conversion for some of their retirement money. Income caps for conversion eligibility have been eliminated, and people who convert some of their retirement savings to Roth accounts will be allowed to pay the required up-front taxes over a two-year period.
Roth IRA contributions are taxed going in rather than when they are withdrawn. Most people decide to convert their deferred-tax accounts to a Roth IRA because they expect to pay lower taxes on their contributions at the time of the conversion than they would on withdrawals in later years when tax rates could be higher. All eligible withdrawals from Roth IRAs and Roth 401(k) accounts are tax free.
Participants of 401(k) plans are eligible to convert their own contributions if they are over age 59 1/2 or they no longer work for the company. Participants who make the conversion within the 401(k) plan will still have to report the money transferred to the Roth IRA as taxable income, but they will not have to withdraw and hold their contributions for 60 days before making the conversion to a Roth 401(k).
Employees may be eligible to convert employer contributions as long as they are at least 59 1/2, or the money has either been in the plan for at least two years or they’ve participated in the plan for at least five years, according to a New York Times report.
Congressional revenue estimators believe the provision will bring the government an additional $5 billion over the next 10 years because taxes will be paid on Roth IRA contributions rather than deferred. Money in traditional IRAs and other tax deferred plans is not taxed until it is withdrawn, which could take many years.
Changes for 2010 in rules for Roth IRA conversions
For tax years starting in 2010, the $100,000 modified adjusted gross income limit for conversions and rollovers to Roth IRAs is eliminated, and married taxpayers filing a separate return can now convert and roll over amounts to a Roth IRA, the IRS Web site states.
For conversions or rollovers in 2010, any amounts that are required to be included in income are included in income in equal amounts in 2011 and 2012. Taxpayers may choose to include the entire amount in income in 2010.
Some rules to keep in mind
2010 is the year of the conversion but not the year the tax is due.
Roth IRA ownersmust be 59 1/2 or older and have held the IRA for five years before tax-free withdrawals are permitted. Early withdrawals are subject to an additional 10 percent tax.