When congress passed its fiscal cliff package for 2013, they included new provisions regarding Roth 401(k)s.  Unfamiliar with Roth 401(k)s?  They offer tax free withdrawals for retirees who invest with after tax funds.  The Roth is appealing to those who expect to pay more in taxes in the future than they do now.  Roth 401(k)s can also help to reduce retirees’  taxable income upon which Social Security is taxed and Medicare premiums are calculated.

The new provisions allow any participant in a 401(k) plan, regardless of how close to retirement they are, to convert all or part of their traditional 401(k) into a Roth 401(K) and continue to contribute to the Roth 401(k) with after tax income if the plan offers the Roth option. Participants would pay taxes on the funds they choose to convert and any company pretax matching funds would be maintained in a separate, traditional 401(k) where taxes would be paid out when the funds are withdrawn.

A few concerns for the Roth 401(k):

  • The conversion to a Roth 401k is not reversible –  Unlike a Roth IRA that allows a participant to change his/her mind and avoid paying taxes, if a Roth 401(k)’s assets decline in value after conversion there is no way to reverse the movement and taxes are still owed on the original value.
  • Participants cannot split the tax payment – Unlike a conversion from an IRA or traditional 401(k) to a Roth IRA that allows participants to split the payment of tax liability into two years, a 401(k) conversion to a Roth 401(k) is paid all in one tax year.

Is your plan sponsor considering offering a Roth 401(k)?

How are they planning to handle the additional responsibilities associated with ensuring participants are educated on the tax consequences and benefits of the Roth 401(k)?