Roth in-plan conversion post preceded by LRPC's Plan Sponsor Insight image.

Whether you sponsor a large or small 401k plan, the addition of a Roth in-plan conversion feature may be viewed by your executives as an important tax planning tool. A major benefit of Roth accounts is that vested balances residing in the accounts for five or more years may be withdrawn tax-free (contributions and earnings) when a distributable event occurs.

A Roth in-plan conversion option is a unique tax planning tool. Roth 401k accounts are the only investments I can think of where the investor has control over when an investment is taxed, without actually having to liquidate the investment! Normally, taxation on an investment is triggered when it is sold, not re-characterized into a different account or form. Consider these other reasons to offer a Roth in-plan conversion feature in your 401k plan:

Reasons To Offer Roth In-Plan Conversions

 

Political

Like it or not, your executive’s benefits and compensation packages are solidly in the cross-hairs of our nation’s legislators. Whether it is from an income equality perspective or a matter of the conventional wisdom at the moment, it is likely that executive comp and benefits will remain under attack. Any enhancement you can provide this group would seem to be welcome.

Political trend

It is pretty clear that the Obama administration feels that retirement benefits should have their limits. How might future administrations view the issue? Many experts believe that a Hillary Clinton presidency is inevitable. That could leave benefits and compensation policy in the hands of Democratic policymakers for the next 10 years. If that happens, do you think tax rates will be higher in the future? Executives might feel that it makes sense to tax some of their 401k plan benefits now at what might be historically low tax rates. Using a Roth in-plan conversion can accomplish that.

Low cost

With such a powerful tool available (where else can you choose when to have an investment taxed without having to sell it?) the cost to implement this plan change must be enormous, right? Not so. You will need to amend your 401k plan to add the feature and then communicate the change to participants. Depending upon your plan’s size, that might mean the total cost of a plan amendment and communication materials falls somewhere between $2,500 and $5,000.

Strategic

I believe that every 401k plan participant should establish a Roth 401k account. Why? If for no other reason than to get the five-year clock started. Remember, a Roth account has to be in existence for five years before amounts may with withdrawn tax-free. However, every dollar does not need to be in an account for exactly five years. Don’t believe that tax rates will be higher in the future? Why not start the Roth five-year clock ticking anyway? It costs nothing (put $10 in it!) and you have nothing to lose.

Huge benefit to young workers

Besides executives, it would seem that those employees just starting their careers might benefit greatly from using Roth 401k plan accounts as well. Since these workers have 30 or 40 years to work, just think of the tax-free balances they could accumulate over their careers. Even if you are cynical and believe the government will change their mind and begin to tax these balances if they get too large, why not start to fill a Roth bucket up now anyway?

There appears to be no downside associated with adding a Roth in-plan conversion feature. It will not cost anything additional to administer each year and is a nice option to offer employees.

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About the Author

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 bob@lawtonrpc.com.

About Lawton Retirement Plan Consultants, LLC

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 bob@lawtonrpc.com or visit the firm’s website at: http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

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.