Big News for 401k Participants.  You may have heard about the special conversion rules that allow traditional IRAs to be converted to Roth IRAs in 2010 with a 3 year payout for the taxes.  If you are not aware, a Roth account is a tax deferred account that is funded with after tax dollars.  A Roth continues to grow tax free, but the homerun is that all distributions are tax free after age 59 ½.

Most participants don’t realize that a 401k can also have a Roth Account.  But with a Roth 401k you could not do any type of conversion from the tax deductible account to the Roth 401k.  That is until recently;   in September, Congress passed The Small Business Jobs Act of 2010, and the regulators are finally getting the information disseminated to us.  A participant in a 401k can now convert their tax deductible contribution account to a Roth 401K (still in the plan) and enjoy 3 years to pay the tax if converted in tax year 2010.  It is called an in-plan conversion.  Participants in the plan do not have to convert the entire amount of their taxable account; they can convert any amount that they would like. In the world of accounting, what I am describing is a Really Big Deal. 

The specifics of the Act now permit employers to amend their §401(k) plans to allow participants to transfer a tax deductible 401k account (the government calls this an Eligible Rollover Distribution or ERD) into their designated Roth account in the plan if the transfer is made after September 27, 2010.

In-plan conversions to a 401k Roth account can be made only if the plan includes the following provisions:

• The plan must allow for withdrawal of before tax contributions and/or certain employer contributions after age 59 1/2, even if the employee is not separated from service.
• The withdrawal of certain employer contributions after participating in the plan for five years, even if the participant is still employed, and
• The plan must allow for Roth elective deferral contributions.
• The plan may limit some or all of the optional withdrawal provisions to in-plan Roth conversions.

 It is important for the employee or 401k participant to realize that any amount that is converted (except in 2010) is taxable in the year of the conversion.  Remember, a Roth by definition means that taxes are paid first, and then the account grows tax free.  If the conversion is made in 2010 there would be no taxable income in 2010, but half the income would be taxable in 2011 and half in 2012.  You can elect to revoke the election and pay all the tax in 2010 if it is more advantageous for your tax situation.  Please consult your tax advisor to review the best option for you. 

This could be a tremendous opportunity.  For example, if you believe you have undervalued assets or assets that will appreciate in your 401k, now would be the time to convert to a Roth Account.  Remember tax free strategies are always the best option.

For More Information from the IRS go to  http://www.irs.gov/pub/irs-tege/n-10-84.pdf