New Opportunities to “Roth”

Recently one of the tenets of the Small Business Jobs Act of 2010 came into effect, providing you with additional opportunities to set aside funds in a Roth account – not a Roth IRA, but rather a “designated Roth account”, often referred to as a Roth 401(k) or Roth 403(b).  Designated Roth accounts are also often referred to as DRACs – just to keep the acronym train rolling.

The way the new law works is that, if you have a 401(k) or 403(b) (the traditional kind), you can roll over or convert some of your funds to a DRAC while the account is still active – as long as your plan is set up to allow in-plan distributions of this variety.

The eligible rollover distribution (ERD) must be made:

  • after September 27, 2010;
  • from a non-designated Roth account in the same plan, meaning your traditional 401(k) or 403(b);
  • because of an event that triggers an ERD from the plan; and
  • otherwise meets the rollover requirements.

Eligible Rollover Distribution

To be considered an eligible rollover distribution (ERD), the distribution is all or part of an employee’s balance in a qualified retirement plan (401(k) or 403(b)), that is not any of the following:

  • A required minimum distribution (RMD)
  • Part of a Series of Substantially Equal Periodic Payments (SOSEPP), also known as a §72(t) plan
  • A hardship distribution
  • Return of employee’s nondeductible contributions
  • Loans treated as distributions
  • Dividends on employer securities
  • Premiums for life insurance coverage purchased under the plan

If you roll over an ERD into a DRAC, you must include first the non-taxed (deductible) funds – but this is also a distribution that is not subject to the 10% early distribution penalty (much like a Roth IRA conversion).  There is no income limit on the conversion.

In addition, just like a Roth IRA conversion, for a DRAC conversion in 2010 you have the option of spreading the tax over 2011 and 2012, with a recharacterization option up to October 15, 2011.

In addition, this new law allows for sponsors of governmental 457 plans to add a DRAC option to their plans in 2011 and later.  Then these plans can be amended to allow the in-plan ERD distribution to the DRAC later on.

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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