Roth Conversions

Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans, and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security, and Medicare. This is where we highlight the most relevant topics affecting your business. A recent call with a financial advisor in New York is representative of a common question on in-plan Roth conversions.

"A client did an in-plan Roth conversion and now wants to undo the conversion. Can an in-plan Roth conversion or rollover be reversed or undone?"

Highlights of the discussion

Unfortunately, in-plan Roth conversions are irrevocable. Consequently, it is essential for those contemplating this type of transaction to discuss the pros and cons with their tax advisors before acting.

Here is the background on in-plan conversions. The Small Business Jobs Act of 2010 (SBJA) amended the Internal Revenue Code (IRC) to allow 401(k) plans to permit in-plan Roth conversions (also referred to as an in-plan Roth rollover). An in-plan Roth conversion is a distribution from a non-Roth account of a participant (typically, a participant’s pre-tax deferral account or after-tax contribution account) that is rolled over to the participant’s designated Roth account in the same plan. In connection with the conversion, the participant must pay taxes on the pre-tax portion of the amount rolled over to the designated Roth account.

In IRS Notice 2010-84, Q&A-6, the IRS confirmed that an in-plan Roth conversion cannot be undone or reversed. Therefore, once the in-plan conversion is completed, the assets must remain in the designated Roth account until distributed to the participant.

Initially, in-plan Roth conversions were permitted only if the participant was eligible to take a distribution from the non-Roth account (i.e., the participant was eligible for an in-service distribution or had experienced a distributable event). However, beginning in 2013, the American Taxpayer Relief Act of 2012 (ATRA) amended the IRC to allow in-plan Roth conversions from non-Roth accounts regardless of whether the account was eligible for a distribution. In-plan Roth conversions are an optional plan feature, so it is important to check the plan document to determine their availability.

There may be some confusion among investors regarding undoing a conversion because, before 2018, it was possible to undo a conversion to a Roth IRA through a “recharacterization.” However, this provision did not apply to in-plan Roth conversions. As a result of the Tax Cuts and Jobs Act (TCJA), conversions to Roth IRAs made after January 1, 2018, cannot be reversed or recharacterized. Today, only traditional IRA and Roth IRA regular contributions can be recharacterized.

Conclusion

In-plan Roth conversions are typically taxable events that cannot be undone. Determining whether a plan offers them and then discussing the pros and cons of completing a conversion with a trusted tax and/or legal advisor is important before proceeding.