Wednesday, February 13, 2013

Budget Deal Lets More Savers Convert To Roth 401(k)s

U.S. workers willing to take tax pain today in exchange for tax-free gains on earnings in their 401(k) retirement accounts later have a new avenue to do so.

The budget legislation passed by Congress Jan. 1 lets 401(k) participants convert any money in their tax-deferred accounts to a so-called Roth 401(k) account, if their employer offers one, which can be withdrawn tax-free in retirement. The change is projected to raise $12.2 billion in revenue over 10 years, according to the Joint Committee on Taxation, and help defray the cost of delaying spending cuts that had been set to take effect this month.

“This dramatically expands the number of participants who can use this provision,” said Bob Holcomb, executive director of legislative and regulatory affairs for JPMorgan Chase & Co.’s retirement plan services. “It will allow any amount to be transferred.”

The conversion opportunity can benefit people with significant balances, the up-front money to pay taxes now with funds outside their retirement account and years of tax-free earnings ahead of them or their heirs. Conversions to Roth 401(k)s had been limited to certain funds and to plans that allowed the switches. The law opens the opportunity to more workers who hold $5 trillion in employer-sponsored defined contribution plans including 401(k)s.

Deferring Taxes

Contributions to a traditional 401(k) account are tax- deferred, with taxes paid at ordinary income rates when the money is withdrawn in retirement. When savers put money into a Roth 401(k) account, they pay taxes on the money upfront in exchange for tax-free withdrawals later.

The new conversion opportunity may help wealthy investors who want to leave their retirement accounts to heirs and younger savers, said John Olivieri, a partner in the private clients group at New York-based law firm White & Case LLP.

“This is really a huge benefit to heirs,” Olivieri said. “Basically you can pay tax now for your kids.”
Younger investors may wish to convert a portion or all of their account if it’s a small part of their net worth because they have more time to make back the money they lose in paying the tax upfront, Olivieri said.

Fund Transfers

A provision in a 2010 law allowed some 401(k) participants to convert part of the money in their plan to a Roth 401(k) account, with restrictions: Their employer had to offer a Roth 401(k) and allow conversions. Funds transferred were limited to money eligible for distribution, such as that held by savers age 59½ and older, and some employer contributions, said Alison Borland, vice president of retirement solutions and strategies at Lincolnshire, Illinois-based Aon Hewitt. It is a unit of Aon Plc that administers 401(k) plans for about 5 million workers.

“Now they are saying you can convert any money,” said Ed Ferrigno, vice president of Washington affairs for the Plan Sponsor Council of America. The Chicago-based group represents about 1,000 employers that sponsor plans and lobbied for the 2010 law change as another way for participants to diversify their savings, Ferrigno said. The budget legislation may encourage more employers to offer Roth 401(k) accounts, even as questions remain about the logistics, he said.

Plan Guidance

“This isn’t going to happen overnight,” he said. “Treasury is going to have to issue guidance. Plans are going to have to make amendments.”

Americans held $5 trillion in defined contribution plans as of Sept. 30, including $3.5 trillion in 401(k)s, according to the Washington-based Investment Company Institute.

About 12 percent of plan sponsors offer and allow conversions to Roth 401(k) accounts and the majority of them don’t charge a fee for it, Borland said. Participants should ask whether there’s a cost for such a transaction, she said.

A taxpayer in the top income bracket with a 401(k) worth $1 million may pay 39.6 percent, or $396,000, in federal taxes this year when converting the entire account into a Roth 401(k). The legislation allows all or a portion of funds in an account to be converted to a Roth within the same plan, Olivieri said. Once the taxes are paid upfront, all of the additional earnings and appreciation in the account are tax-free, he said.

Congress has turned to Roth accounts before as a revenue raiser.

The government lifted income restrictions on converting an individual retirement account, or IRA, under a provision of a 2006 law that took effect in 2010. That’s when U.S. taxpayers making more than $100,000 a year in adjusted income could start making the transfers. There’s no limit on conversions if an investor has multiple IRAs, nor a cap on the amount that can be shifted.

PMA Profiles - Zare Tokatlian

Over the past 15 years, when client's have called PMA, chances are that they have spoken with Zare Tokatlian, EA - this month's focus for PMA Profiles.

Zare was born in Erevan, Aremia (when it was still part of the Soviet Union) and immigrated to the United States at the age of 14.  He graduated from Hollywood High School, of all places, where he excelled in Tennis and Soccer, sports which he still follows passionately today. However, his true passion lies in music.

Before becoming an accountant, Zare lived the life we all wanted at one time or another - he was a lead guitarist for his band, Shirak. Shirak, with music inspired by the Beatles, toured the Eastern seaboard playing to packed houses. But alas, Zare realized that his future was waiting for him, back in Los Angeles. The band eventually broke up, but he can still bring it if he picks up his electric guitar.

Zare's favorite food is Shishkabob and enjoys cooking for his entire family, especially when its special occasions like birthdays, the holidays, or graduations. And just as he enjoys cooking, he loves spending time with his wife and two wonderful children. As a family, the have traveled to Sevastopol, Mexico and several other exotic places.

When asked if he can be an instant expert in anything, he replied, "I would love to be an expert in figuring out how Congress thinks when it comes to the tax code"! ... Wouldn't we all!

Zare received his Enrolled Agent designation in 2010 and has been an integral part of PMA's growth through the years.

Next time when you call the Diamond Bar offices of PMA, and Zare happens to answer the phone, say hello to him and ask him about his tennis game! And if you are a tennis player as well, he may take you up on a friendly match!