New retirement savings option: Rolling regular 401(k) money into a Roth 401(k)

A provision in the recently enacted Small Business Jobs and Credit Act now offers some employees a new way to enhance their retirement savings.

Under the law, certain amounts in 401(k) workplace retirment plans can be rolled into workplace Roth 401(k)s. The conversions are also allowed for 401(k) counterparts: 403(b) plans for nonprofits and 457(b) plans governmental jobs.

The reason for wanting to change traditional 401(k) money to Roth 401(k) cash is the same as with traditional and Roth IRAs. When the regular retirement account money is withdrawn, you'll owe taxes on it at your ordinary income tax rate. But when Roth 401(k) funds are distributed, they are tax-free.

And the 401(k) et al rollover rules offer, again just like the new regular-to-Roth IRA conversion opportunity, the option to pay any taxes due on the traditional retirement money over two tax years, 2011 and 2012.

Why the rollovers? So why did Congress decide to create the workplace plan Roth rollover rules now?

First, the 401(k) provision raises $5.1 billion over 10 years. Remember, when converting a traditional retirement plan to a Roth, the account owner must recognize income -- that is, pay taxes -- on the money that is converted.

So workplace retirement savings that might not be taxable for many years now could produce substantial federal revenue. As Congress searches for every available dollar in these deficit conscious times, that prospect was quite appealing.

Second, several employer groups were concerned about so-called leakage out of workplace retirement plans.

Before the small business act's changes, the only way to convert traditional workplace retirement money into Roth savings was to roll the regular 401(k) into a Roth IRA. And this wasn't possible for many workers since they made too much money.

But when the $100,000 threshold limit was removed this year, more people were permitted to roll retirement money into a Roth IRA.

Since the option to convert a taxable plan to one that ultimately is not taxable, there was concern that many high-income employees would withdraw their workplace money to roll it into a Roth IRA.

Converting eventually-taxable retirement money to an account that won't be taxed in the future can be very advantageous for many individuals. And the new 401(k)-to-Roth 401(k) option is definitely one you at least should look into.

But first, check out some additional details and restrictions on the workplace retirement plan conversions in my Bankrate Taxes Blog post New Roth 401(k) rollover option.

Related posts:

• Tax breaks in the new small business bill
• Are you ready for a Roth?
• Are you ready for a Roth conversion?
• Roth IRAs and your retirement income
• Handy retirement plan rollover chart
• 401(k) Do's and Don'ts

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