Employers can offer a new 401(k) retirement account starting January 1, 2006. The Roth 401(k) merges the traditional 401(k) account with the tax benefits of the Roth IRA. The new Roth 401(k) is funded using after-tax dollars and withdrawals from the account are tax-free while the traditional 401(k) is funded with pre-tax dollars and withdrawals are taxed as income.
The Roth IRA has income eligibility limitations for single filers making more than $110,000 a year and joint filers making more than $160,000 yearly. The Roth 401(k) has no restrictions and as long as an employer offers this retirement account option, anyone may invest for their retirement using this financial vehicle. There are no minimum distribution requirements for the new Roth 401(k) account either.
Selecting between the accounts may require some planning though. The tax treatment of each retirement accounts’ withdrawals is the difference at retirement age. If you believe the government will be raising taxes to pay down the country’s debt point or if your tax rate is high now, you may find the Roth 401(k) attractive. If you anticipate having a lower tax rate into the future, you will find the traditional 401(k) to be a better paying choice.
“Fewer people may choose to take part the more complex these plans get,” cautions Martha Priddy Patterson, a Deloitte Consulting benefits policy analyst speaking with the Boston Globe.
“With a traditional 401(k) you can save tax now and maybe use the tax savings for current discretionary spending, perhaps to take a vacation, but with a Roth you can have the freedom of withdrawing money tax-free any time you want after you retire,” said Paula Chauncey, a Boston financial advisor. Kevin Queally, a Merrill Lynch advisor said that “Paying tax upfront can help these people build up a larger amount of after-tax assets to tap.” Both Chauncey and Queally were speaking with the Boston Globe.
“It really boils down to your effective tax rate when you’re employed and when you’re retired. For most people, they’re probably going to have less money in retirement, so the traditional 401(k) will probably be the best for them,” said Chris Bowman, vice president for retirement and investor services with the Principal Financial Group Inc. speaking with the Des Moines Business Record.
Nearly 53 million workers were participating in 450,000 traditional 401(k) plans at year-end 2004 according to Retirement Resources Inc. These accounts totaled some $2.85 billion. Contributions of employees less than 50 years of age can total $15,000 across both types of accounts while those over 50 can contribute $20,000.
“We have already received a number of calls from our employers who are excited about encouraging their people to save more for retirement,” said Jean Duffy, vice president of financial services with Holms Murphy & Associates Inc.
Although not available until January 1, Roth 401(k) accounts were authorized by Congress as part of the Economic Growth and Tax Relief Reconciliation Act of 2001. The program will expire at the year-end 2010 and no deposits will be allowed after program expiration unless Congress extends the program.
Guidance for establishing 401(k) plans is available from the IRS.