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IS A ROTH 401(k) RIGHT FOR YOU?
Sharing characteristics of both 401(k) and Roth IRAs, the Roth 410(k) retirement savings vehicle allows you to save after-tax dollars in a tax deferred retirement account without the income restrictions and contribution limits that apply to Roth IRAs, and when you reach retirement, qualified distributions are tax free. (The Roth option may also be available to those with sponsoring 403(b) accounts.)
COMPARE AND CONTRAST
Currently, only taxpayers whose adjusted gross income (AGI) falls below certain levels ($116,000 a year for single filers and $169,000 for joint filers) are eligible to contribute after-tax dollars to a Roth IRA. These income limits do no apply to Roth 401(k)'s. Furthermore, you can save more money in a Roth 401(k) than in a Roth IRA.
The 2008 annual contribution limits for IRAs of all kinds are set at $5,000 for taxpayers under the age of 50 and $6,000 for older workers. The Roth 401(k) is subject to the more generous elective salary deferral limits that apply to conventional 401(k)s-$15,500 for taxpayers and $20,500 for those over the age of 50 in 2008.
The Roth 401(k) has other advantages over the Roth IRA. Contributions can be easily and conveniently made through payroll deductions. To participate, an employee currently contributing to a traditonal 401 (k) plan could, for example, simply opt to have his or her contributions diverted to a Roth version of the same plan.
Matching contributions made by employers must be invested in a traditional 401(k), not a Roth account. This means that, even if you make contributions exclusively to a Roth 401(k) account, you would still owe tax in retirement on withdrawals from funds contributed on a pre-tax basis by your employer.
The 401(k) annual deferral limits apply to all 401(k) contributions, regardless of whether they are made on a pre-tax or after-tax basis. If you contribute to a Roth 401(k), you may have to reduce or discontinue your contributions to your employer's conventional 401(k) plan to avoid exceeding these limits; however, you may contribute to both types of 401(k) plans.
With a Roth 401(k), you will be required to begin taking distributions after the age of 701/2, and you will not be permitted to withdraw earnings tax free until you have held the account for at least five years and are at least 59 1/2 years old. These provisions could make the Roth 401(k) less attractive to employees who are currently approaching retirement.
WHICH CHOICE IS RIGHT FOR YOU?
In order to decide which options or combination of options works best in your retirement plan, it is important to weigh the advantages and disadvantages of both types of 401(k)s. With a traditional 401(k), you make contributions on a pre-tax basis, which lowers your current taxable income, and earnings are tax-deferred; however, your retirement distributions will be subject to ordinary income tax. With a Roth 401(k), your contributions are not tax deductible, but earnings and distributions are tax free, provided you meet the five year ownership and age requirements. The right shoice for you depends on your current tax situation and your long term financial goals.
If a Roth 401(k) makes sense for you, ask your company's benefits administrator if the feature is available for your retirment plan. If it is not already in place, expressing interest in the Roth feature increases the likelihood your company will adopt the option.
