Now’s the time to consider a Roth conversion of ‘aftertax’ money.
The lede: While the battle rages in Washington over which taxes to raise and which estate planning devices to kill, there is one loophole that is almost certainly going to be closed soon–by the end of this year if the current version of the bill passes: The Roth “conversion” of aftertax money in retirement accounts. Nobody is lobbying to save this little wealth-builder that should never have existed in the first place.
Not many people have aftertax money in their IRAs or 401(k) accounts. Among those who do, some don’t have enough to bother with, and others will not be able to convert it to Roth status separately from the account’s pretax money. But anyone who has a worth-bothering-with amount of aftertax money in an IRA or employer plan may want to take action (if possible) to convert that aftertax money to a Roth IRA while you still can.
If the Aftertax Money Is in a Qualified Plan
Most people do not have any aftertax money in their employer retirement plans. Some who do:
- An older client who has been working for the same company for many years may have an “employee contribution account” from contributions made years ago. Such an account contains the employee’s contributions (aftertax money, also called “basis”) and the growth thereon (the “earnings”), which is pretax money.
- Aware of the attractive loophole of converting aftertax money, more employers have been permitting employees to top up their annual plan additions with voluntary aftertax contributions to such an employee contribution account.
- Rarely, an employee who borrowed money from a retirement plan without fully complying with plan-loan limits and rules will have aftertax money in the plan as a result of the defective loan having been treated as a taxable distribution (even though it was repaid).