Friday, January 5, 2007

“After” Math

You may find a new option on your retirement plan savings menu this year - the Roth 401(k). Initially incorporated in the Economic Growth and Tax Relief Reconciliation Act of 2001, the Roth401(k) option became available for the first time on January 1, 2006, and the recently enacted Pension Protection Act extended the benefits of the Roth 401(k) indefinitely.

Will a Roth 401(k) Work for You?

While every situation is unique, experts suggest that a Roth 401(k) works best for workers who expect their tax rate to be higher in the future, since, with the Roth option, you are paying taxes now rather than deferring them into the future, as with a standard 401(k). This should make the Roth 401(k) option particularly attractive for younger workers (who are currently in 15% or 25% tax brackets). It also might be considered an attractive option by workers- who expect tax rates overall to be higher in the future than they are today, particularly higher-income workers.

Many workers already have a Roth IRA, and even more have a 401(k) balance. So, what's a Roth 401(k)? As the name suggests, it is really a combination of the two savings options.

It is like a Roth IRA in that:

• Your contributions are made on an after-tax basis.

• Earnings on those contributions accumulate on a tax-free basis.

• Withdrawals taken during retirement are not subject to income tax, so long as you are at least age 59-1/2, and have had the account for five years or more.

It is different from a Roth IRA in that:

• There are no compensation limits imposed for eligibility.

• You may defer more in a Roth 401(k) (see below).

It is like a 401(k) in that:

• Your contributions may be matched by your employer.

• Your contributions—Roth 401(k) and regular 401(k) combined—are subject to the current 401(k) deferral limits ($15,000 in 2006, or $20,000 for those 50 or older by the end of the year).

• The rules for withdrawals are the same.

It is different from a 401(k) in that:

• The contributions are made on an after-tax basis.

• Earnings accumulate on a tax-free basis, rather than tax-deferred (subject to withdrawal limits).