Fiscal Cliff Legislation May Affect Retirement Plans

The fiscal cliff legislation, named the American Taxpayer Relief Act of 2012 (ATRA), contains a last-minute provision that could involve your retirement plan. This is an optional change that employers, who are plan sponsors of 401(k), 403(b), or 457 plans, may choose to offer their employee participants by way of plan amendment. 

As of January 1, 2013, these employer-sponsored plans have an option to amend their plans to allow any participant to transfer pre-tax account balances into an after-tax Roth account that is established within the same plan. Some plans already offer a Roth account on a more restrictive basis. Formerly, the law authorized participants who were eligible for a distribution, such as retirees over age 59 ½, to make such an in-plan transfer. But, employers need to amend their plans to open up this new, broad based, in-plan transfer opportunity. It is the decision of the plan sponsor (i.e., the employer) whether to amend their plan to authorize this new “in-plan” option.

What specifically is allowed and why? ATRA makes this change to IRC section 402A(c)(4) with very few words and no stated restrictions. The hope is that if enough plans offer it, and enough individuals elect to use this in-plan rollover option, more tax revenue will be raised now as opposed to later. Funds transferred from the pre-tax account to the after-tax Roth account become immediately taxed, rather than deferring the tax until the individual retires (or takes a final distribution). Essentially, individuals are deciding whether they want to pay tax now, at current rates, or later at whatever rate they are in at time of distribution. There are, of course, other details involved in such decisions which will be communicated by plan sponsors who elect to offer this option.

When the earlier, more restrictive option was offered under the Small Business Protection Act of 2010, the IRS published Notice 2010-84 to describe how this in-plan rollover from a pre-tax account to a Roth account works. Until further guidance under ATRA is published, employers might want to review this earlier IRS Notice.