You CAN’T Change Your Mind on a Roth 401(k) Conversion

By Joe Cicchinelli, IRA Technical Expert

Follow Me on Twitter: @JoeCiccEdSlott

While many of us know that you can convert an IRA to a Roth IRA, a process that’s not as well understood is a Roth 401(k) conversion. If you participate in a 401(k) at work, you can convert your existing plan assets to a Roth account inside the 401(k) plan. This option is known as an “in-plan conversion.” But check with your employer first because although the law allows an in-plan conversion, your plan may not have this option.

The in-plan conversion rules also apply to 403(b) plans, governmental section 457(b) plans, and the thrift savings plan of the federal government. The Roth account inside your 401(k) plan is called a designated Roth account in the tax code. The in-plan Roth conversion will be taxable to you, but the funds inside the Roth account will grow tax-free if certain rules are followed.

Previously, you had to be eligible to get a distribution from your 401(k) plan to do an in-plan conversion. However, that rule changed this year. Beginning in 2013, you’re now allowed to do an in-plan conversion even if you’re not yet eligible to take a distribution from your 401(k).

The major problem with an in-plan Roth conversion is that once you do it, there’s no turning back. By contrast, if you convert IRA money to a Roth IRA, the law allows you to change your mind, or reverse it. The IRS calls this a “recharacterization.”

Unfortunately, the rules don’t allow you to undo (“recharacterize”) an in-plan Roth conversion, so make sure it’s the right move before you do it. As we said earlier, because an in-plan conversion will be taxable to you, you’d better be sure you’ll have the money to pay the taxes you’ll owe. Also, if, after an in-plan conversion, the value of that Roth account drops due to poor investment performance, you’ll still owe taxes on the value of the assets converted as of the date of the in-plan conversion.