Weak equity markets have one silver lining for those executives in your organization that might have large 401k account balances: In-plan Roth 401k conversions.
Roth In-Plan Conversions
Most of us have experienced significant declines in the value of our 401k account balances as a result of weak equity markets. For executives, these losses may have been even greater if they had a well-diversified 401k account with a heavy allocation to equities and exposure to commodities. These executives may have unrealized losses in their accounts of as much as 20% or 30%.
Converting pre-tax 401k balances into after-tax Roth 401k balances results in taxation of the previously tax-free amounts. Converting when the account value is lower may result in a substantial tax savings. Following is an example.
Example of in-plan Roth 401k conversions
Let’s assume one of your executives has a $1,000,000 account balance and is interested in converting 20% of it into a Roth 401k account. Prior to the recent decline in market value, assume that the existing $200,000 slice of this executive’s account was worth $300,000. In other words, assume the executive has experienced a 33% decline in the value of his/her account.
Taxes are due on any amounts converted into Roth 401k accounts. So the executive would owe state and federal income taxes on the $200,000 of his/her account balance that was converted. However, the executive would save paying taxes on the difference between the previous value of $300,000 and the current value of $200,000. In this example, an executive subject to a combined 30% state and federal tax rate would save $30,000 in taxes, and possibly much, much more.
Additional benefits of Roth 401k accounts
Roth 401k account balances residing in the accounts for five or more years and withdrawn for permissible reasons are not subject to any state or federal taxes when distributed. We know the markets will bounce back and assuming that this executive experiences a reasonable rate of return for the next 10 years, his/her tax savings on the $200,000 that is converted and withdrawn completely tax-free sometime in the future could be enormous.
What you should do
In-plan Roth 401k conversions can benefit almost any plan participant. In order for your 401k plan to permit such exchanges, it needs to allow for Roth 401k accounts and in-plan Roth 401k conversions. If your plan currently isn’t structured this way, don’t worry, all you need to do is amend it.
There aren’t many benefits your executives can enjoy these days. Consider sharing this opportunity with them.
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton has over 30 years of retirement plan consulting and administration experience and has provided consulting services to many Fortune 500 companies including: Aon Hewitt, Apple Inc., AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Car Company, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or email@example.com.
Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Advisory (RIA) firm providing investment advisory, fiduciary compliance, employee education, vendor management and plan design services to 401(k) plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or firstname.lastname@example.org or visit the firm’s website at: http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.
This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.