Quick Summary: Roth In-Plan Conversions, if your company allows them, should be given serious consideration. The benefits can be tremendous if your unique personal situation fits the parameters. But be warned, regardless of any potential benefits you’ll need to pay taxes by tax day of 2022 on any conversion done in 2021. Many people don’t have that kind of cash to execute.
Sometimes, it’s better to be lucky than good …. I’ve said this thousands of times in my lifetime and this was one of those times. If it wasn’t for me clicking around my Vanguard 401k account I never would have seen that small little button that said “convert my savings to Roth.” But even those words didn’t tell me much so I clicked the button. And as I read the Roth in-plan conversion FAQ’s I was getting very intrigued.
I read a lot of financial articles. For years, probably 15-20 personal financial articles every single day and not once do I remember reading about these conversions. So, I Googled “Roth in-plan conversion” expecting to find article after article of insightful information to help me understand what this was. All I found was Fidelity, Vanguard, and others explaining the details. Why I haven’t heard much about it and will this benefit me? Honestly, it sounded pretty damn cool but nobody is talking about it. There are hundreds of articles on backdoor Roths, Roth IRA conversions, and even mega backdoor Roths but hardly anything about Roth In-Plan Conversions.
Today’s article is my first step into the world of Roth In-Plan Conversions. I’m sure I’ll learn more as I execute and experience the process but we’ll at least put pen to paper on my understanding of this useful (to some) conversion.
WARNING: Before executing on a Roth In-Plan Conversion, please do your research, understand your personal situation, make sure you have the cash to pay the extra taxes, and please seek help from a professional accountant or financial planner (or both) before you convert. This process is not to be done without serious thought and planning.
Roth In-Plan Conversions
In simple terms, a Roth In-Plan Conversion is moving funds from your current work pre-tax 401k to your current work after-tax Roth 401k.
You’ve got to have both a pre-tax and post-tax Roth 401k available to you at work. Not everyone has both … my large company just provided us with a Roth 401k this year (thank goodness!). Usually, every participant in the plan is eligible to convert funds. And if you convert funds you CAN NOT undo the conversion. So, before you click the button to convert please make sure it’s something you can and want to do.
This is not a Roth IRA rollover, which has it’s own set of rules and merits. Roth IRA rollovers is written about often in the personal finance space and it was something that I planned to do in retirement. That was before I found the ability to do an in-plan conversion. The benefits of the Roth In-Plan Conversion are the same as rolling over money into a Roth IRA … tax-free growth and withdrawals after 59 1/2 years of age. And before you can withdraw any funds, they must be in the Roth 401k for at least 5 years.
Who might want to do a Roth In-Plan Conversion? If you expect your tax rate to be the same or higher, it might serve you well to convert. If you don’t need the money for at least 5 years it might serve you well to convert. Do you want to leave your heirs tax-free money then converting might be a good way to go. And if you want the tax diversification in retirement by having tax-free funds available then consider converting. Finally, if you can pay the tax on the conversions then it might make sense to convert. For us, we fit all of those considerations.
Tax Implications & Other Considerations
Doing a Roth In-Plan Conversion needs to be thought through very carefully. Of course, the biggest thing to consider is taxes. We aren’t Nostradamus but we have to put some kind of futuristic thought into our own tax situation. And this isn’t a prognostication but, if I were to bet, I’m thinking rates will have to go higher.
One thing we do know at this point in time is that personal income tax rates were not made permanent. If congress doesn’t do anything then personal rates will change on January 1, 2026. Rates will revert back to the 2017 rates. And not only do the rates change but so do the thresholds. It’s this change that has me converting money this year.
Another important consideration is required minimum distributions (RMD). If you haven’t looked at the tables, RMDs can be really taxing especially if you don’t need the money at 72 (like me). With my pension, social security, and dividends my income will cover everything I need. Pulling from my 401k/IRA would be unnecessary. And remember, my Roth 401k/IRA will be my 3rd (last) bucket in my scheme. Pulling from these funds would be my last resort and they are targeted to be inheritance funds for my kids (and our last resort). Knowing your purpose for these funds is important to know.
Finally, Medicare premiums need to be considered. Premiums calculations look at your two prior years of income so we’d like to minimize an already expensive health insurance situation with even higher premiums. That means converting now could mean lower premiums later.
This points to the me seeing a benefit to convert funds using the Roth In-Plan Conversion. My plan was to convert these when I retired but when my company finally created a Roth 401k and allowed in-plan conversions it created a great opportunity to start converting now.
My Conversion Plan
To be transparent, I’ve already converted $40,000 in 2021 … I did this last week. As I get closer to year-end, which is when I recommend you normally does these conversions, I’ll see if it makes sense to convert another $15,000. I think it’s best to wait until year-end because weird income windfalls can occur. For example, when the 2017 Tax Plan was approved, my company accelerated our bonuses in December. Normally, I’d receive the bonuses in March of the next year. That acceleration unexpectedly increased my income in 2017 by about $75,000.
This $75,000 was completely unexpected and I didn’t know about it until early December. If I had done a big Roth In-Plan Conversion and then received the early bonuses then it would have moved me well into the next bracket. This would have wrecked my plan and I’d be paying a much higher tax on the conversion.
This roadmap is just a plan that will be reviewed each year. The one thing I do know is that I’ll move money over every year until I retire. I just don’t know how much until I get closer to the year-end of each year. So, it’s good to have this plan or roadmap but it will be fluid and updated each year.
And when I get into 2025, I’m not sure I’ll convert the remaining $196,000. I may roll-over any remaining amount to an IRA and slowing do a Roth IRA conversion. That will be a Roth IRA Conversion and not a Roth In-Plan Conversion. But I have a plan and that’s the important thing.
Summary
Do I think these Roth In-Plan Conversions are hidden gems? Yes, if they fit your personal financial plan. My company did not notify me that this was available and few blogs specifically talk about them. Not every company has a Roth 401k available to them (this is my first year with one). And not every company allows this capability within their plan. So, from that perspective then I do think they are a hidden gem. Again, please check with your advisor first because there is a lot to consider (and they can’t be undone).
I will take these one year at a time but I’m thrilled that I can start moving regular 401k funds to a Roth immediately. Seriously, I’m absolutely thrilled because I was going to move them over post-retirement but that would have impacted my Medicare premiums at a minimum.
I can’t say I’m lucky to have found this capability. I’m a strong personal finance reader and I poke around and research (hunt) for these kinds of opportunities. Sure I stumbled upon it when I was perusing Vanguard but I like to think I made my own luck.
Thanks for reading!
Mr. TLR