Both paths move after-tax 401(k) dollars into Roth. They differ in where the Roth money lands, how the earnings are taxed, and which tax forms you reconcile at filing time.
The comparison
| Dimension | In-plan conversion | In-service distribution |
|---|---|---|
| Roth lands in | The 401(k)'s Roth account | An external Roth IRA |
| Earnings before conversion | Taxable as ordinary income at conversion | Taxable as ordinary income at distribution |
| Form 8606 | Generally not required for the in-plan rollover itself | Tracks after-tax basis rolled to the Roth IRA |
| Tax forms received | 1099-R (in-plan rollover, often code G) | 1099-R (distribution) + 5498 (Roth IRA rollover-in) |
| Roth IRA flexibility | Subject to plan rules and investment menu | Full Roth IRA investment choice and access rules |
| Usual preference | Preferred, especially if automatic per pay period | Good substitute when in-plan conversion is unavailable |
Why automation matters either way
The amount of taxable earnings depends on how long after-tax dollars sit before they are converted. A plan that converts automatically every pay period keeps the taxable sliver near zero. A plan that requires you to request conversions quarterly — or only allows annual in-service distributions — gives earnings more time to accrue, and those earnings are ordinary income when you convert. Frequency, not just permission, drives the tax outcome.
The basis-tracking difference
With the in-service-distribution path, you are moving after-tax basis out of the plan and into a Roth IRA, and Form 8606 is where that basis is reported. With the in-plan path, the conversion happens inside the plan and the recordkeeper handles the accounting; you generally do not file Form 8606 for the in-plan rollover itself. See the Form 8606 walkthrough and the 1099-R / 5498 reconciliation for the line-level detail.