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Because last night's Senate bill (HR 8) has more new spending than new revenue, a new section was added permitting in-service conversions from a traditional 401(k) to a Roth 401(k).

A little more below the fold.

As the WSJ explained:

Of that $24 billion cost, $12 billion would come from a shift in the rules affecting workplace-based 401(k) plans. The change would allow plan holders to roll their 401(k) assets into a Roth IRA plan, which would require them to pay taxes up front on any gains in their plan. The benefit for investors would be that disbursements from Roth plans in retirement are tax free.

In effect, the move provides more up-front revenue to the Treasury, but potentially at the cost of revenue over the long term—as taxes paid when individuals make withdrawals from their 401(k) plans would likely be far greater.

This change was in Section 902 of HR 8. While the Small Business Jobs Act of 2010 permitted rollovers from a standard 401(k) to a Roth 401(k), it was only permitted in certain circumstances: the account owner had to be at least 59.5, the age at which distributions from IRAs and 401(k)s are permitted without penalty1. Now, however, taxpayers can always convert a tax-deferred 401(k) to a tax-free Roth 401(k) by rolling the former into the latter and paying the tax liability on the balance. That can be a pretty big tax hit, but after the funds are converted, there is no tax at all on either the earnings or the distributions.  And, importantly, the longer the assets are in the Roth wrapper, the bigger the tax pony is for the account beneficiary.  

So who does this benefit?  Well, I don't think it'll benefit me very much.  If I did a conversion, I'd pay tax on the rollover at my marginal rate.  But I'd be prepaying my tax liability at my tax rate while I'm working versus the tax rate I'll pay when I'm in retirement.  Since I don't anticipate having much in the way of income during retirement, I'd be paying a higher rate now versus a much, much lower rate in retirement.  The upshot is that it may not make sense for me - or most people! - to do a conversion given that we'd be paying more now versus less (or none!) later.

So who does benefit?  Well, people that will have a decent amount of income during retirement, which is to say wealthier people whose investments generate a good amount of income. And I fully expect them to take advantage of this tax pony.

Congress, of course, fully expects and intends them to take advantage of it: they'll take in a good slug of revenue in the next few years as people convert their accounts and pay the associated tax liability. The loss to the Treasury, on the other hand, won't manifest until those taxpayers start to retire, which could be many decades from now and is well beyond the 10-year horizon for budget scoring.

1 There are a few other circumstances under which it is permissible, such as death or disability. See IRS Notice 2010-84 (pdf) for more detail.

2 My wife's resolution for the new year is, apparently, to tell me to clean more, so I'll be checking back sporadically whenever I find time between chores, diaper-changing, etal.


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Comment Preferences

  •  Thanks for pointing this out (2+ / 0-)
    Recommended by:
    Lujane, Molly Weasley
  •  I have a friend (who wishes to (7+ / 0-)

    remain anonymous) who was able to stick $100 million into his 401(k). He recently lost a presidential election and is now thinking about moving his $100 million to a Roth 401(k). Any advice?

  •  People with variable incomes also benefit. (1+ / 0-)
    Recommended by:
    johnny wurster

    My income has varied by 10x since 2000.  For one year, I did not even make enough to cover the standard/personal deductions.  When you're flipping between tax brackets, it can be fairly significant to save at the 25% or 35% rate and flip to a Roth at the 10%-15% rate.

    Even a few 10k flipped properly can add up to several thousand dollars of real benefit.  Especially if you're in your 30s or 40s and have plenty of time to let it grow.

    -7.75 -4.67

    "Freedom's just another word for nothing left to lose."

    There are no Christians in foxholes.

    by Odysseus on Tue Jan 01, 2013 at 10:06:42 AM PST

  •  I read a comment in a retirement and (1+ / 0-)
    Recommended by:
    johnny wurster

    Tax-planning column (I wish I could remember where) that suggested caution with Roth IRAs.

    The gist of the advice is that while right now Roth earnings aren't taxable, Congress made that law. So a future Congress can change that law. If we have a Congress obsessed about the debt, they might do that; or if we have a national emergency.

    The example used is the mortgage interest deduction. People bought and are buying homes assuming that that will "always" be there. But as we've seen, it's not safe from being tossed on the negotiations table. Its days may be numbered.

    So, its something to think about. I generally thought of Roths as pretty good deals, especially if you're young enough to have time to earn decent returns.

    But the question is, how much does one trust Congress generally? And not just now but an unknown Congress in the future to keep the promise of past Congresses?

    Thanks for the diary. I didn't realize conversions were part if the new deal. It's something to keep in mind (yes, in spite of what I just wrote. It's always a balancing act, eh?) . Would that be effective ASAP, starting with the 2013 tax year?

    © grover

    So if you get hit by a bus tonight, would you be satisfied with how you spent today, your last day on earth? Live like tomorrow is never guaranteed, because it's not. -- Me.

    by grover on Tue Jan 01, 2013 at 12:12:53 PM PST

    •  yep, effective as soon as the bill passes. (1+ / 0-)
      Recommended by:

      I've had a number of.clients that haven't done conversions because of the risk that congress would.change the rules after the fact.  I think the risk of that is slim to none, personally, but reasonable people.can differ.

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