Today The Small Business Jobs Act of 2010 was passed by the Senate. Its virtually assured to pass the house next week.
One of the provisions of the Act is to allow participants in a retirement plan to convert their balances over to a Roth account.
Back in 2006, a new section of the tax code created something called “Designated Roth Accounts” for 401k plans. They are pretty much exactly how they sound, 401k participants are allowed to fore go the tax deduction on contributions, and in return when they make distributions, the distributions come out tax free.
A little known aspect of this provision is that it is considered a means for the government to earn more money. As you can no doubt guess, Congress thinks short term and the short term result of this code section is less people will be able to take tax deductions for their 401k contributions as they will want to make the contributions to the Roth side of the plan.
Well, evidently Congress thought a really great way to raise revenue would be to allow people to convert some of the 17 trillion dollars they have in retirement plans over to Roth 401k funds. Since people will have to pay taxes immediately on the conversion, Congress can in effect jump start the expected cash flow from retirement distributions. Instead of waiting 30 or 40 years for the revenue, the government gets it now.
Great idea, but just a couple of challenges.
The first is the lesson we learn from lottery winners. When people receive a windfall of money they typically aren’t the best stewards of that money and end up broke in a few years. Its pretty much a foregone conclusion the government is going to waste this windfall as well and ignore the long term consequences of the tax free growth of the Roth accounts.
The other big challenge is that only 29% of retirement plans have even been modified to allow for the designated Roth accounts. That means the vast majority of savers aren’t even going to be able to take advantage of this great opportunity.
If you have money inside a retirement plan, ask you trustee or administrator if you have the Roth feature, if not you owe it to yourself to ask that they make the feature available. By way of shameless promotion, here a link to one of our websites that offers Roth 401ks for dirt cheap.