Employers can now offer participants the option of converting pre-tax contributions to Roth contributions. This option is a result of the American Taxpayer Relief Act that was passed in January. The Act brought new changes to Roth 401(k) rules, including the option of Roth conversions. Plan sponsors may offer this option to participants of plans that allow in-plan conversions and contain a Roth option.
The American Taxpayer Relief Act (ATRA) was passed by
ATRA allows plan sponsors to offer the option of converting pre-tax contributions into Roth contributions. Previously Roth conversions were available only to those whose distributions were already eligible for rollover. Roth conversion can now occur even if the contributions are not currently eligible for distributions.
Roth contributions are made with after tax dollars which can later be withdrawn tax-free. While the tax break is not given upfront, it is given at the point of withdrawal, allowing a source of tax-free income during retirement. Earnings on Roth contributions are also tax-free if the account is held over a period of five years and the participant has reached age 59 1/2 or is disabled or deceased.
This new change allows for greater diversification of tax exposure during retirement, an important but often overlooked component of retirement planning. A heavy tax burden can quickly drain retirement savings. As retirement continues to be the top concern for most Americans, Roth conversions present a valuable retirement strategy. A Roth retirement account can provide a source of tax-free income during retirement.
Because Roth conversions place the tax burden at the outset, factors such as age and income should be considered before opting for conversion. Those who can allow the fund to grow for a longer period will benefit the most from Roth conversions. Income is also a factor in choosing the Roth conversion option. If the conversion moves the participant to a higher income tax bracket, it may not be an effective strategy for tax diversification.
Sense Financial Services, a provider of retirement accounts in
Sense Financial is
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