As I stated before, one of the provisions of the “fiscal cliff” deal was a provision that allowed 401(k) plan participants to convert their pre-tax salary into a post-tax Roth 401(k) deferrals that will be distributed tax free at retirement. All that’s required is that the participant’s employer’s plan offers the Roth feature. Only 40 to 50% of all 401(k) plans have that Roth feature.
So the only requirement to make the conversion is that the employer plan have that Roth feature. Previous law only allowed Roth 401(k) conversions for participants with so-called “distributable” funds, a relatively small group that mainly included people 59 1/2 and older.
Why did the government allow this provision under the euphemistically titled American Taxpayer Relief Act of 2012? Well, it’s a gimmick to raise revenue because if a participant converts from pre-tax deferrals to post-tax deferrals, a tax bill is due. These conversions are a financial gimmick to get a boost of tax revenue now, and not worry that retirees may get tax free treatment at retirement later. It’s called kicking the can and that’s what the Federal Government does as I still notice that Social Security will run out of money the year before I’m supposed to collect my benefits.
This gimmick of Roth 401(k) conversions is supposed to raise $12 billion over the next 10 years. Here’s three reasons why it won’t:
- A majority of 401(k) plans still don’t offer Roth.
- Thanks to the recession and a very weak recovery, 401(k) participants aren’t exactly flush with cash to pay taxes for a conversion.
- 401(k) participants don’t believe they will have a higher tax bracket at retirement (which means tax free retirement distributions would sound better) or more importantly, they don’t believe that the government will hold up their end of the bargain and keep Roth 401(k) distributions tax free.
As with any gimmick, there are some benefits to it and if I had $5 to my name, I’d consider it. The problem is that most 401(k) plan participants won’t and the government won’t get the revenue they think they will get.