How to Maximize In-Plan Roth Conversions in 401(k) Plans

By Martin James, CPA, PFS

January 5, 2024

How to Maximize In-Plan Roth Conversions in 401(k) Plans

Key Points – How to Maximize In-Plan Roth Conversions in 401(k) Plans

  • What Is an In-Plan Roth Conversion?
  • Key Considerations for In-Plan Roth Conversions
  • Walking Through an Example
  • Potential Educational Benefits
  • 5 Minutes to Read | 24 Minutes to Watch

Understanding In-Plan Roth Conversions

Many employer 401(k) plans offer in-plan conversions (referred to as in-plan rollovers in plan documents) of pre-tax amounts to the designated Roth accounts. Doing the in-plan Roth conversion will result in a current income tax bill on the converted amount in most cases. Many plan participants are unaware this option exists.

“It wasn’t in the original 401(k)s when they were designed. Neither was the Roth 401(k).” – Marty James, CPA

First, there were just pre-tax contributions. Then, the Roth was added to it. And later, in-plan Roth conversions were made available. There is also the opportunity for certain employees to put after-tax contributions in. In other words, you get no tax deduction on it.

The difference between that and the Roth funding is that with the Roth funding, there is no upfront government loan in the form of a tax deduction on your paycheck. But it’s all your money and the earnings are tax-free. With the after-tax contribution, it goes in with no deduction, but the earnings on it will be taxable.

Looking at the most current plan summary plan description will reveal the options available, as will a call to the plan administrator to get more details. You will be looking for pre-tax accounts, Roth accounts, after-tax accounts, and the in-plan rollover options.

Key Considerations

In most plans, the source of the contribution is maintained even if the funds are converted from a pre-tax or after-tax contribution. This is important when considering withdrawal options before age 59½ while still employed. Many plans allow pre-59½ withdrawals of after-tax contributions and rollover contributions.

The strategy for a W-2 employee that has all the options is to start the year by making pre-tax contributions, even if their intent is to fund the Roth 401(k). An analysis would need to be done to see the difference between a pre-tax contribution paycheck and a Roth contribution paycheck.

ADP has an online payroll check calculator to use for this analysis. The pre-tax contribution paycheck will be higher. The employee should save the difference between the paychecks. If the market corrects to the downside, convert those contributions to the designated Roth account in 401(k). This will result in a taxable event, and you’ll get a 1099 at the end of the year.

“Once you do it, you’re done. You can’t recharacterize that, so you need to make sure you get those numbers exactly right. Everybody is individual in terms of where they need to be.” – Marty James, CPA

An Example of an In-Plan Roth Conversion

However, if you had contributed $10,000 to date and were in the 24% tax bracket, you would have $2,400 saved to pay the taxes on the conversion. Let’s say the $10,000 is now worth $9,000 in a normal 10% correction. The taxes on the conversion would be $2,160. The difference of $240 from the paychecks would be a permanent tax savings to the employee and a permanent loss to the government. It would be as though the $10,000 contributions earned another 2.4%.

For the employee, the actual correction was not 10%; it was only 7.6%. The $9,000 is now 100% owned by the employee. The government no longer has a claim on any future growth. If the correction was 30% down, the savings would be $720 or 7.2%. That would result in an actual correction down of 22.8% for the employee.

“For people who have a lower income, it’s not quite as powerful, but it would still work. You just really need to be diligent with watching your balances and seeing when the opportunities are there.” – Marty James, CPA

What If There Isn’t a Clear Opportunity to Do an In-Plan Roth Conversion?

If an opportunity does not present itself during the year to do an in-plan Roth conversion, do the conversion of the contributions at the end of the year. The employee would have saved the taxes to pay the taxes on the conversion and would be in the same position tax wise if they had contributed to the designated Roth account all year. The only difference would be any growth trapped in the pre-tax account.

If the plan has after-tax contributions, the employee may be able to make contributions to that account and convert immediately to Roth (many plans have a feature that automatically converts after-tax contributions to the designated Roth account). This is done to reduce any gains that would result in a taxable event on the conversion.

Once in the designated Roth account and if the plan allows pre-59½ distributions of after-tax contributions, the employee can roll the converted after-tax contributions into a Roth IRA. This rollover amount would be considered as a contribution in the Roth IRA and not a Roth conversion, allowing immediate access to the Roth funds, but not earnings in the Roth IRA pre-59½.

Educational Benefits

Funds in the Roth could be used to fund education expenses for children before the employee is 59½. Contributions would be non-taxable upon distribution and the $10,000 education exception could apply to earnings. This strategy for education funding could help with the issue of over funding a 529 plan, which should be used in conjunction with this strategy.

For FAFSA purposes, tax-free Roth distributions including the contributions are considered as income. But money in the retirement plan is not considered as an asset.

Have Any Questions?

If this is the first time you’ve heard about the opportunity to do in-plan Roth conversions, please don’t hesitate to reach out if you need some additional clarity about them. The same goes for anyone who has been aware about in-plan Roth conversions but wants to know more about them.

“This is an additional strategy for us as CFP® Professionals to go in and say, ‘I’ve got something that’s rather interesting. You’ve probably never heard of this before. Here are the pros and there are very few cons associated with it. Lay it out straight and see what the numbers look like.” – Bud Kasper, CFP®, AIF®

It’s also critical to work with a tax professional when looking into things like in-plan Roth conversions. They could be an amazing opportunity for you or they might not be in your best interest. It depends on your unique situation.

While the focus of this article has been on in-plan Roth conversions, we’d be remiss if we didn’t share our Roth Conversion Case Studies white paper below with you as well. We reviewed scenarios where Roth conversions make sense for someone, as well as a situation where it doesn’t. Download your copy below to find out more about the pros and cons of Roth conversions.

In-Plan Roth Conversions

Roth Conversion Case Studies

The CPA and CFP® Professional Relationship

At Modern Wealth, we have CPAs in-house that work alongside our CFP® Professionals and review financial plans from a tax perspective for various tax planning opportunities and to ensure that you don’t make costly tax-related mistakes.

“Let’s figure out how you pay as little tax over your lifetime, not how you pay as little tax in a single year.” – Dean Barber

In-plan Roth conversions are one of many tax planning strategies to keep in mind as you’re building a forward-looking tax plan. You can start a conversation with our team below to see if in-plan Roth conversions could make sense for you.

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Our team of professionals is obligated to put your needs, wants, and wishes and of our own. It’s our goal to provide you more confidence that you’re doing the right things with your money, freedom from financial stress, and time to spend doing the things you want to do.

How to Maximize In-Plan Roth Conversions | Watch Guide



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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.