Can I Convert an Employee Savings Plan to a Roth IRA?

by Cindy Quarters

An employee savings plan (ESP) can be any of a number of different types of savings plans sponsored by a person’s employer. These can include a generic ESP, where the employer deducts and puts the employee’s money in a trust, but the employee manages it. Or, it can be a plan such as a 401k, which is a very specific type of plan that typically provides the employee with a menu of choices of money management opportunities.


The Pension Protection Act (PPA) of 2006 was enacted to allow employees more control over their money. The PPA greatly increased the number of plans eligible to be rolled over into a Roth IRA. Virtually any type of IRS-qualified employee savings plan is eligible for conversion to a Roth IRA. The amount can either be rolled over directly from the savings plan, or you can take it as a distribution paid to you and then place it in a Roth IRA within 60 days.


In most cases taxes will be withheld from your distribution if you choose to have your employee savings plan money distributed directly to you. The flat 20 percent withholding will apply, and if you are not yet 59 1/2 an additional 10 percent penalty will be withheld. When you place the funds into a Roth IRA you will be able to get some or all of this money back, but you won’t see it until you file taxes the following year. A direct conversion avoids withholding, and the full amount is deposited into your Roth IRA. Normally you will need to pay taxes on any previously untaxed funds that you place in your Roth IRA from any other account.


A Roth IRA has benefits that most other employee savings plans do not. When your money is in a Roth IRA, it will grow tax-free until you remove it during retirement. Since taxes were paid on the money at the time you deposited it, you are able to withdraw funds from your Roth IRA tax free. This includes both the principal amount and any earnings from your money. You can also set up a payment schedule to allow you to stretch your distribution dollars out for as long as you wish.


Some funds that are distributed to you are not eligible to be rolled over into a Roth IRA. These include such things as required minimum distributions, which begin when you reach age 70 1/2. Funds that were distributed to you as hardship funds, regular disbursement payments and distributions to correct overages in your account are also ineligible to be converted to a Roth IRA. In general, it is best to only use funds removed from your savings account specifically for conversion purposes for funding your Roth IRA.

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