You may
have read and/or heard about the Roth 401(k), and you may be wondering if this a
good option for your clients and their employees. The Roth 401(k) feature can
be very valuable for some, but much less so for others. Your clients need to
look at their workforce and evaluate their plan's specific needs as it relates
to Roth.
What is a Roth 401(k)?
The Roth
401(k) became available as a new retirement savings option on January 1, 2006.
The plan is a hybrid that combines
features of Roth IRAs and traditional 401(k) plans, but it differs in important
aspects.
A Roth
401(k) is similar to a Roth IRA in that it allows
after-tax contributions to fund tax-free retirement income.
However, a Roth 401(k) allows for sharply higher annual contribution amounts
than a Roth IRA — up to $15,000 ($20,000 if older than age 50) in the 2006 tax
year versus just $5,000 for a Roth IRA.
Best of
all, most plan providers are not charging any extra fees for Roth – something
to keep in mind when you are evaluating services.
It is important
to note that an employee can only take advantage of the Roth 401(k) if his or
her employer has decided to offer it.
How does a Roth 401(k) compare to
other plans?
Roth 401(k) plan
|
Roth IRA
|
Traditional 401(k)
plan
|
Employee contributions are made with after-tax
dollars.
|
Employee contribution provisions are
the same as a Roth 401(k) plan.
|
Employee contributions are made with before-tax
dollars.
|
Investment growth accumulates without
any tax consequences.
|
Investment growth accumulates without
any tax consequences.
|
Investment growth accumulates without
any tax consequences.
|
There is no income limitation to
participate.
|
Income limits are:
Married couples,
$160,000; Singles, $110,000 adjusted gross income.
|
Income limits are the same as a Roth
401(k) plan.
|
Contributions are limited to
$15,000 in 2006 ($20,000 for employees 50 or over).
|
Contributions are limited to
$4,000 in 2006 ($5,000 for employees 50 or over).
|
The contribution limits are the same
as Roth 401(k) plan.
|
|
*Taxes on earnings
Since contributions have already been
taxed, earnings are not subject to taxation if participant is:
- At least 59 ½ or
-
Disabled or
-
Deceased
and contributions are held for at
least five years.
|
*Taxes on earnings
These are the same as Roth 401(k) plan.
|
*Taxes on earnings
Withdrawals of both contributions and income earned are subject to taxation.
|
Who is the Roth 401(k) appropriate
for?
The Roth
401(k) isn't for everyone. It really depends on the situation of the employee
and the employer. As a general rule, a Roth 401(k) fits particularly well with
highly paid employees who will find themselves in a high tax bracket during
retirement.
Here are
three scenarios to consider when deciding if the Roth 401(K) is appropriate for
your clients:
If your client believes that tax
rates are going to increase in the future and/or that he/she will be in a higher income tax
bracket at retirement, then Roth deferrals make sense. This usually applies to younger
employees with a long time horizon until retirement.
If your client already has a large
traditional 401(k) account, it could make sense to contribute on a Roth basis in the future.
This will help them "hedge" their bet on future tax rates and have
the flexibility to make taxable and non-taxable distributions in retirement,
based on tax considerations.
If your client wants more
flexibility for estate and retirement planning, a Roth 401(k) may be something
to consider. For example, if a Roth 401(k) account is rolled over into a Roth
IRA, the minimum required distribution rules would not apply. This means that your
clients would not have to start taking distributions (withdrawals) at age 70.5
if their assets were rolled into a Roth IRA.
You cannot roll a traditional 401(k) into a Roth IRA, only a Roth
401(k).
How do I get more information on
the
Roth 401(k)?
Here is a
list of resources and articles that you can read to find out more about the
Roth 401(k) or pass on to your clients:
Chad Parks is the president and CEO of Decimal, Inc., the leading provider of no-hidden fee, Web-based retirement plans for small and single-person businesses. For more information about Decimal, visit
www.theonline401k.com. Mr. Parks can be reached at (877) 775-401k or via email at
cp@theonline401k.com.
