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Can I Convert a Coronavirus-Related Distribution to a Roth IRA?

DWC 02/25/21


We added Coronavirus-Related Distributions (CRDs) to our 401(k) plan in 2020, and a number of our participants availed themselves of the new feature. I know they have the option to pay any applicable taxes all at once or spread them over three years, and I also understand they have up to three years to roll the money over to avoid taxes altogether. But I’ve overheard several participants talking about using this as an opportunity to convert the distributed amount to a Roth IRA.


Can participants combine the three-year spread for taxes and the ability to repay a CRD to do a Roth IRA conversion without taking a tax hit all at once?


We’ve heard this question come up a few times. There’s quite a bit to navigate here, so let’s unpack this question one step at a time. As much as we’d like to provide a clear cut “yes” or “no” answer, there are some different interpretations. We’ll start with a quick recap of some of the basics and then provide background on the different opinions so that you can decide where you land based on your specific circumstances, risk tolerance, etc.

Quick Recap #1 - What is a Coronavirus-Related Distribution?

CRDs were made available by the CARES Act, beginning in March 2020. A participant who met specific criteria to demonstrate s/he was negatively impacted by the coronavirus could take a penalty-free distribution from his/her retirement plan. Although the normal early withdrawal penalty is waived, the distributed amount is subject to regular income tax. To lessen that potential financial burden under the circumstances, the CARES Act gave participants the option to spread the tax liability evenly over three years and/or to repay some or all of the distribution back to a plan or IRA. Since the option to take a CRD expired on December 30, 2020, we won’t go into greater detail here; but if you’re curious, we’ve got you covered here.

Quick Recap #2 - What is a Roth IRA Conversion?

In order to convert a pre-tax plan account to a Roth IRA, a participant must first have some event that makes him or her eligible to take a distribution from the plan - typically reaching age 59 ½ or terminating employment. The amount withdrawn from the plan is rolled over to a Roth IRA account. Although not subject to a 10% early withdrawal penalty, these pre-tax dollars are always includible in gross income and subject to both Federal and State tax for the year in which the distribution takes place. Having that tax liability hit all at once can make Roth conversions cost-prohibitive for anyone who doesn’t have extra cash to use to pay the tax bill. While not directly on point, we cover in-plan Roth conversions and transfers here.

Back to the Question at Hand

As is common in the often-confusing world of new rules and regulations, there are some differences of opinion here, so we will touch on a both. Before proceeding, however, we should start by saying that when all of this is boiled down, it is ultimately an individual tax question. As such, the best advice we can give is for participants to speak to their tax advisors for appropriate direction.

If They Didn’t Say No…

“Yes” seems to be the minority (and, thus, more aggressive) opinion. These individuals point out that there is no overt prohibition of a CRD to Roth conversion. With that said, laws and regulations are rarely written that clearly. They are more a game of connect the dots rather than just drawing a straight line. Moreover, this group argues that while CRDs are eligible for tax-free rollovers, there is nothing that states a participant must roll it over. And, in that case, why not consider forgoing the current tax benefits available for a CRD and instead take advantage of a Roth conversion?

Connecting the Dots

On the flipside, the more predominant opinion, in our experience, is a resounding “No” - that a participant can’t convert a CRD to a Roth IRA. Here’s why. For starters is the argument that it violates the spirit of the law. Congress passed the CARES Act to provide assistance to those negatively impacted by COVID, not to provide tax avoidance strategies that have nothing to do with the pandemic.

Moving more to the letter of the law, folks in this camp point to IRS Notice 2020-50 which specifically states that CRDs that are timely recontributed (i.e., within three years) are not includible in gross income. It does not provide an option on this point. So, if a re-paid CRD cannot be included in gross income but a Roth conversion must be included in gross income in the year of conversion, it doesn’t take Sherlock Holmes to deduce that this precludes a CRD-to-Roth conversion. See what we mean about connecting the dots?!

There are some on both sides of this debate who believe the answer is crystal clear. While a spirited debate can always be interesting, this will come down to a question of risk tolerance for many participants. As with any transaction that has tax implications, we highly recommend seeking the assistance of a tax professional to discuss the options, associated risks, and any potential downfalls that might apply to the participants specific situation.

Even if you did not adopt CRDs for your plan in 2020, there’s actually another pretty good reason to think through this. The Consolidated Appropriations Act of 2021 provides for penalty-free distributions in areas where a federally declared disaster occurs in the future. This Act provides participants the opportunity to take CRD-like distributions (think a waiver of the 10% early withdrawal penalty, distributions of up to $100,000, and ability to pay taxes over a three-year period) when their principal residence is in the disaster area. This means similar questions are likely to arise in the future as participants look for creative Roth conversion options.

If new or expanded guidance is provided around Roth conversions and disaster relief distributions, you can count on us to report back to you. If you have any questions in the meantime, we're here to help you dig in and get the answers you need. Got any topics you’d love to see us cover here? Drop us a line!


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Topics: Question of the Week (QOTW), DWC, In-Service Distributions, Plan Distributions, CARES Act/Coronavirus, Roth, Coronavirus-Related Distributions, Roth Conversion


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The views expressed in this blog are those of the authors and do not necessarily represent the views of any other person or organization. All content is provided for informational purposes only and is not intended to be tax or legal advice.