A provision tucked into a small business jobs bill that Congress just passed would broaden the appeal of 401(k) plans.
Late last week Congress passed the Creating Small Business Jobs Act of 2010, which would provide small businesses with incentives to expand and hire new workers.
To help pay for the bill, taxpayers would be allowed to roll over 401(k) and government retirement account funds into Roth accounts — as long as participants pay taxes on those funds. If the rollover is made this year, a participant could elect to pay the tax on the funds in 2011 or 2012. Those taxes would then fund the bill’s small business incentives — tax cuts, loan programs, etc.
Benefits for plan participants
Under existing law, employees make pre-tax contributions to 401(k) plans. Then when an employee receives a distribution from the plan (usually upon retirement) the employee contributions, employer matching contributions and investment income are taxed.
But in a Roth 401(k), contributions are made after taxes and thus distributions are not taxed.
Because of the new bill 401(k) participants could theoretically save a great deal in taxes — depending on their current and future tax brackets — by rolling over their regular 401(k)s into Roth accounts offered by their employers.
Example: If tax rates increase in the future (as many economists predict they will), participants who converted funds from a 401(k) to a Roth 401(k) and paid taxes on those funds now would end up paying less in taxes than if they kept the money in the regular 401(k) and withdrew funds later.
And while plan participants can currently roll over funds into Roth individual retirement accounts (IRAs), the fees charged in those IRAs are usually higher than those in employer-sponsored plans.
Update: President Obama has signed this bill into law.