Switching to a Roth 401k now made easier

In an attempt to raise current year tax revenue, the so-called fiscal cliff legislation passed in early January allows those with an employer-sponsored traditional 401(k) to convert to a Roth 401(k). The catch: the employer must have a Roth 401(k) option available to its employees, and the plan must also allow in-plan conversions. If not, an employer looking to give employees such an option must update their retirement plan documents—which takes time.

Similar rules were passed in 2010, but the recent legislation takes things a step further. In the 2010 bill, only money that was already eligible for distribution (for instance, if you had reached the 59 1/2-year-old withdrawal threshold) could be converted. The fiscal cliff bill allows any money in the traditional 401(k) to be converted.

Depending on your expectations of future tax rates, conversion could be a wise move. Because you don’t get a current year tax deduction on your Roth contributions, but withdraw the money tax-free during retirement, Roth’s make sense for anyone who expects their tax rate to be higher during retirement. Just remember that the conversion will create a bigger tax bill in the current year. Since the traditional 401(k) contributions were tax-deductible, you’d have to pay the taxes when moving to the Roth. Make sure you have the funds available to pay those taxes before converting.

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