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New Legislation Lets Savers Convert Traditional 401(k) To Roth 401(k)

For most of your working life, most contributions made toward your impending retirement has been to a qualified plan, meaning a plan that allows you to take a tax deduction in the current year of contribution as in a Traditional IRA, or in the case of corporate working folk, their 401(k). There are two phases we go through during our lifetime with regard to money. The first is the accumulation phase, which is the time we spend saving. The second phase is known as the distribution phase, which we use to supply us with income as a result if the decades we so diligently saved during the accumulation phase. While we enjoyed the tax deduction all those years we were able to utilize to lower our annual taxes, at some time or another when we retire, it’s time to pay the tax man. Now, all of the 401(k) contributions plus all growth will be fully taxable as ordinary income upon withdrawal. So, as much as the annual deduction gave us lower taxation in the years we made the contributions, with the income being fully taxable we now have to pay the piper. Thanks to the new budget Deal worked out by Washington in the Fiscal Cliff mess, we have a ray of sunshine for you savers: Congress will now allow you to convert your 401(k) to a Roth 401(k), as long as your employer offers this option. As with Traditional IRA conversions where you converted your Traditional IRA to a Roth IRA, you may now do it with your 401(k). As noted above, check with your employer to see if they have in place a Roth 401(k), and in light of the new legislation, you may encourage them to adopt one. The conversion will allow your retirement money to continue to grow tax deferred, but when you retire and enter the distribution phase, the income from this block of funds will be tax free, thus giving you more money in your pocket at retirement time when you will most need it. The downside? Any conversion amount from the Traditional 401(k) will be added to your current year taxes taken as ordinary income, and the tax responsibility may be hefty depending on how much you convert. We suggest strongly that you consult your tax advisor prior to converting to make sure you can afford the additional taxes in the year your convert.

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