The Fiscal Cliff and your Retirement Savings

The term that has been come to be known as “fiscal cliff” typically is in reference to increased tax rates for people with the highest of incomes.  The good news is that there is another component of this that helps people in terms of their retirement.  The new law allows employees with employee-sponsored 401(k), 403(b) or government 457 retirement plans to roll over their account balance into Roth retirement accounts, if this option is available within the same plan.

What makes this interesting is that the taxes on contributions to traditional 401(k) plans are typically deferred until the money is withdrawn, while Roth contributions are taxed upfront and can be withdrawn tax-free at retirement.  This was created by legislators to raise approximately $12 billion in tax revenue over the next ten years.  Converting your retirement plan into a Roth is attractive because upon retiring, you may be at the same or even a higher rate of tax.  Additionally, this would help you to avoid a tax bill when you begin taking retirement.

Prior to the passing of the American Taxpayer Relief Act of 2012 (the fiscal cliff law), you could only roll your money over to a Roth if you had a “qualifying event”.  A qualifying event would include changing jobs to a different company, turning age 59 ½, or retirement.  Many (more than 40%) employers already offer this feature of the Roth, but it is estimated that this 40% will rise significantly as more employees request such an option in their retirement plan.

The condition that you need to consider is whether or not it makes sense for you to pay the taxes that will be due at the time of roll over.  Additionally, you should research whether or not any potential tax benefit in the future outweighs the benefits you would see if you left your money in a traditional 401(k) or similar plan. 

Remember that the new law which took effect in January does not reduce or eliminate the previous maximum amounts that can be contributed to a plan in any given year, and the money you contribute does not count as taxable compensation (it is still pre-tax).

This is why it is very important to consult with a financial professional to review how converting to a Roth might impact your retirement savings and tax liability in both the long- and short-term.