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On September 27, 2010, President Obama signed into law the Small Business Jobs Act of 2010.   Under the new law plan sponsors are permited 401(k) and 403(b) to amend their plans to permit vested account balances that can be distributed as an eligible rollover distribution to be converted to Roth amounts within the plan.

Requirements for In-Plan Roth Conversions

A plan may permit in-plan Roth conversions only if the plan is a 401(k) or 403(b) plan that has a Roth elective deferral arrangement.  For example, a profit sharing plan would not be eligible to offer in-plan Roth conversions.

If a plan permits Roth conversions, a participant can only convert amounts that are otherwise distributable under the terms of the plan and qualify as eligible rollover distributions.  Under the Internal Revenue Code, the maximum extent to which in-service distributions are permissible depends on the type of contribution:

* Participant 401(k) deferrals are generally distributable only upon the participant’s severance from employment, death, disability or attainment of age 59½.
* Employer matching and profit sharing contributions generally can be distributed while a participant is actively employed if the employer contributions have accumulated for a fixed number of years, upon the attainment of a stated age or upon any other stated event.  Internal Revenue Service (IRS) rulings have clarified that the “fixed number of years” generally must be at least two years, but that a plan can permit a full distribution of all employer contributions after a participant has participated in the plan for a period of at least five years.  These “two-year/five-year” rules are commonly accepted as the most liberal rules a plan can permit for in-service distribution of employer matching and profit sharing contributions.
* After-tax and rollover contributions are generally freely distributable at any time.

Traditional 401(k) and Roth 401(k) plans

In a traditional 401(k) plan, employee contributions are usually made on a pretax basis; that is, deducted from your pay before federal and state income taxes are calculated. This lowers your taxable income and therefore, your taxes. You don’t pay taxes on these savings or their investment earnings until they’re withdrawn – usually after retirement.

With a Roth 401(k) you contribute after-tax dollars. Although you don’t get an upfront tax break, your account grows tax-free and withdrawals aren’t later taxed, provided you’ve had the account at least five years and are age 59 ½ or older – or have become disabled or die.

Key points:

* The combined 2010 annual limit for employee 401(k) contributions – whether regular and/or Roth – is $16,500 ($22,000 if over 50).
* Roth 401(k) contributions cannot later be converted moved into a regular 401(k), or vice versa.
* Before age 59 ½, all 401(k) withdrawals, whether Roth or regular, may be subject to a 10 percent early withdrawal penalty on the taxable amount.
* Withdrawal exceptions may be made for death or disability, catastrophic medical expenses, first-time homebuyer loans and being 55 or older at retirement or job termination.
* Required minimum distributions (RMD).  For both you must begin taking mandatory minimum distributions from your account after you turn 70 ½
* Conversions.  You can avoid mandatory withdrawals by converting your Roth 401(k) into a Roth IRA, which has no such requirement. You can also convert a pretax 401(k) into a regular IRA and then into a Roth IRA; but you must pay tax on the converted amount, just as you would with any regular 401(k) withdrawal.