In-Plan Roth Rollover: Practically Useless

A new law passed last year, Small Business Jobs Act of 2010, added a provision to allow participants in 401k or 403b plans to move their money from a traditional 401k or 403b account to a Roth 401k or 403b account within the same plan. This is called an “in-plan Roth rollover.”

As a practical matter though, it’s useless to almost everyone.

I say this not just because I’m not a fan of Roth 401k or Roth 403b. First it’s hard to qualify. When you qualify, you realize you are able to do it all along, to your own IRA with better investment options. Finally it may not be a good idea to do it anyway. In the end, it’s practically useless.

To qualify for an in-plan Roth rollover, your plan has to offer the Roth 401k or Roth 403b feature. More and more plans are offering that. So far so good. Then the plan has to be amended to allow this new type of rollover. Maybe your plan has been amended accordingly, but employers aren’t required to do so, just as they are not required to offer Roth 401k or Roth 403b.

Next, you must be eligible for a distribution from the plan. This means either you are already over 59-1/2 or your plan allows an in-service withdrawal for employer money, your after-tax money, or money you previously rolled into the plan.

This requirement excludes most participants under 59-1/2 from doing an in-service Roth rollover. If you are excited about Roth 401k and you’d like to convert your own pretax contributions in the traditional 401k account to Roth 401k, you are pretty much out of luck if you are under 59-1/2. You still have to wait until you leave the employer.

For those who are eligible for an in-service Roth rollover, there’s still not much advantage to do so within the plan. The eligible amount can be taken out of the plan and rolled over to an IRA, either traditional or Roth. When you rollover to your own IRA, you get to choose the best investments. There’s no point in staying in the plan which usually has inferior investment options.

Whether you do the in-plan Roth rollover or rollover to your own Roth IRA, you will have to pay taxes on the amount rolled over. Everything I said in The Case Against Roth 401(k) still apply. You have to be sure prepaying taxes now makes sense.

Altogether, you can benefit from an in-plan Roth rollover only if:

1a. You are already 59-1/2; or

1b. Your plan allows an in-service withdrawal; or

1c. You left your money behind in your previous employer’s plan

2. The plan offers the Roth 401k or Roth 403b feature

3. The plan has been amended to allow in-plan Roth rollovers

4. The plan has better investment options than you can find elsewhere

5. You prefer Roth and don’t mind paying taxes now

What percentage of 401k/403b participants fit this profile? Very small. For the vast majority, an in-plan Roth rollover is useless.

Why did they bother to make a new law for this? I’d say it helps 401k and 403b plan providers retain assets. Instead of seeing assets leaving the plan for a Roth IRA rollover, they get to advertise this in-plan Roth rollover thingy. Some will be confused and convinced to stay.

Reference: IRS Notice 2010-84, Guidance on In-Plan Roth Rollovers