Can I turn my posttax 401(k) into a Roth?

Though a Roth 401(k) account is also funded with after-tax dollars, the tax code has different rules for Roth accounts and after-tax accounts in retirement plans. The after-tax portion of a 401(k) should be tracked and accounted for separately from the rest of the 401(k) by the plan’s record-keeper. The after-tax portion of the 401(k) should be comprised of after-tax contributions and earnings on those contributions. The earnings have not yet been taxed but the contributions clearly have. The plan should be able to tell you what each of those amounts are. 

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You can convert an after-tax account into a Roth account in a couple of ways.

Now, 401(k) plans may allow but are not required to offer “in-plan conversions.” An in-plan conversion to a Roth account within the 401(k), will not avoid taxes because the conversion itself triggers taxes on the untaxed earnings. Further, an in-plan conversion will not stop Required Minimum Distributions (RMD) because Roth 401(k)s are subject to RMD. Only your personal Roth IRA is exempt from RMD. So, to avoid taxes on future earnings and RMD, you need to get the 401(k) funds to a Roth IRA.

If an in-plan conversion is not permitted in your plan or is otherwise unattractive, there are other pathways to convert the 401(k) money to a Roth IRA. Before converting, you first must satisfy the RMD on the 401(k) plan if you are subject to one for the current year. This RMD can only be satisfied by taking a distribution from this 401(k) plan. It cannot be satisfied by taking funds from any other account.

If you are not retired, get a copy of your Summary Plan Description from your HR department. There is a small chance that the plan has a provision that allows you to skip RMD while still employed at the company sponsoring the plan, assuming you do not own 5% or more of the company. I say “small chance” because if you had that provision in the plan documents, you would probably have heard about it by now and would not be taking RMD.

Regardless of whether you can stop RMD while working, a provision that is common in plans is an “in-service distribution.” This is available typically at age 59 ½ and allows you to take money out of the 401(k) plan even if still working and actively contributing to the plan. If you have an in-service distribution provision in the plan, you should look at the provisions applicable to the after-tax account. The plan may allow you to transfer the after-tax contributions to a Roth IRA and the untaxed earnings on those after-tax contributions to a traditional IRA. From there, the Roth IRA has no RMD, and you can reduce RMD on the traditional IRA by converting and paying tax on the conversions as I described above. 

If you are retired, after dealing with any applicable RMD, you should be able to transfer the after-tax contributions to a Roth IRA and the untaxed earnings on those after-tax contributions to a traditional IRA. Done properly, these transfers do not trigger taxation.

The after-tax contributions, now in a Roth IRA, are no longer subject to RMD. The earnings, now residing in a traditional IRA become part of the RMD protocol for your IRAs. After satisfying your RMD, you could then convert any portion of the traditional IRA to the Roth IRA, pay taxes on the conversion and end RMD on those dollars as well.

If you have a question for Dan, please email him with ‘MarketWatch Q&A’ on the subject line. 

Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne, and Tampa Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some reader questions are edited to aid the presentation of the subject matter.