What about Converting your 401(k) to a Roth 401(k)?

Back in September, Congress opened a new door to tax-free retirement income the right for workers with 401k plans to convert their balances to Roth 401ks. Now just like an IRA conversion, you have to pay tax on the amount move to the Roth account, but that down payment could make all withdrawals tax-free in retirement. As you know, withdrawals from regular 401ks are taxed in your top tax bracket. To encourage 2010 conversions, Congress even OKd the same break that applies to 2010 IRA conversions. Rather than pay the tax with your 2010 return, you can pay half with your 2011 and the rest in 2012. Sounds sweet, but there are problems. First, this opportunity is only for workers whose plans offer the Roth option and that also permit in-service distributions, which means you can take the money before you leave your job. And that`s generally only applies to those over age 59.5. The fact is, if your plan allows in-service distributions and you want a Roth you`re probably better off transferring your money out of your employer`s plan and into a traditional IRA. Then you can convert that IRA to a Roth. Why the rigmarole? The two-step procedure buys you some important protection. If the value of the Roth IRA falls between now and next October, you can undo the conversion and move the money back into the traditional IRA. That lets you avoid paying tax on money that has disappeared. There`s no do-over option for a Roth 401k conversion.
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