Personal Finance: Fiscal cliff measure has prize for savers

Personal Finance: Fiscal cliff measure has prize for savers

January 23rd, 2013 by By Chris Hopkins in Business Diary

Chris Hopkins

Chris Hopkins

Photo by Contributed Photo /Times Free Press.

Deep within the American Taxpayer Relief Act of 2012 (the fiscal cliff deal), Congress enacted rules to make the Roth 401(k) option more accessible for retirement savers.

What is the Roth 401(k) you ask? Well, think Roth IRA inside your 401(k) account.

Originally authorized in 2010, this option for defined contribution retirement plans was devised to allow after-tax contributions that grow tax-free until disbursement in retirement, subject to certain stipulations (age 59.5 and at least five years since the account was established), just like the familiar Roth IRA.

Until now, however, making conversions from traditional plans into a Roth 401(k) was somewhat difficult and subject to many restrictions.

In adopting the tax increase plan at the end of the year, Congress included new rules that make the conversion process much easier and available to many more plan participants.

The key changes involve so-called "in-plan" conversions; that is, converting existing retirement plan balances into tax-free Roth 401(k) accounts.

If your employer's plan includes the Roth option, you may now choose to transfer an existing pre-tax 401(k) balance over to a new Roth account by including the amount converted in your taxable income and paying the taxes due on the amount converted.

Henceforth, the balance grows tax-free (again subject to the conditions noted).

You also may make elective salary deferrals into your new Roth account, but the amounts contributed do not reduce your current income (they are after-tax contributions).

Any employer-sponsored matching contributions still are considered pretax payments and must be made into a separate (traditional) 401(k) account. However, these matching contributions also could be converted at a later date.

The decision to move an existing plan balance into a Roth 401(k) should be taken carefully.

The advantage is greatest for younger workers with more time to grow the assets, for those who expect to be in higher tax brackets in retirement, and for those seeking to pass on assets to heirs tax-free.

Also, unlike a typical Roth IRA conversion, retirement plan conversions have no "do-over" provision if the account value drops because of market volatility. No looking back.

One might think that the enhanced Roth options were aimed at improving the retirement savings profile for hard-working Americans, but one would be wrong.

The provision is a budget gimmick from the fiscal cliff deal: get enough participants to convert and the government generates an additional $12 billion in short-term revenue over the next decade, intended to offset the cost of delaying the budget sequestration for two months. This is the budgetary equivalent of a sugar high; once the conversions are made, no more revenue. Ever.

Meanwhile, for many workers, the opportunity is intriguing and should be considered.

So far, roughly half of U.S. employers have included the Roth 401(k) alternative in their traditional plans, but look for more to come in the months ahead. Talk to your plan administrator if you are interested in exploring your options.

Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Christopher A. Hopkins CFA, is a vice president at Barnett & Co. Submit questions to his attention by writing to Business Editor Dave Flessner, Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by emailing him at