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Roth 401(k) plans were legislated into existence by the Economic Growth and Tax Relief Reconciliation Act of 2001. However, they were not set to begin until 1/1/2006 and were given a life span which lasted only through 2010.
The Pension Protection Act of 2006 permanently extended the use of Roth 401(k) plans. Now it becomes more important to understand the advantages and disadvantages of these plans.
Advantages
1. The biggest advantage may be for high income individuals. If you are comparing the Roth 401(k) against a Roth IRA, you will find the Roth IRA has upper income limits. If you are married and file a joint return and your adjusted gross income exceeds $166,000 (for 2007), you cant have a Roth IRA. The Roth 401(k) has no income limits.
2. You can contribute more. For 2007, you can contribute up to $4,000 to a Roth IRA if you are under 50 and up to $5,000 if you are 50 or over. For the under 50 crowd, a Roth 401(k) allows up to $15,500 and for those 50 and older $20,500.
3. If you are over age 50 and still have some “catch-up provision” contributions coming to you, you can put those in the Roth account.
4. If your employer offers the Roth 401(k) option, you can have both. Simply allocate whatever percentage you want into your regular 401(k) and the Roth 401(k) accounts.
5. Roth 401(k) plans can be rolled over to a Roth IRA or to another Roth 401(k) if you switch employers.
6. Withdrawals from the Roth account can be made without paying income tax or the 10% premature penalty if you have had the Roth account for five consecutive tax years and you are at least 59 ½, disabled, or dead (whoever said the IRS doesnt drive a hard bargain?).
Disadvantages
1. Your employer may not want to offer the Roth 401(k) option.
If your existing 401(k) plan provides for a Roth election, the plan has to set up separate accounts and record keeping systems for the Roth contributions. This costs money and may be a deterrent to offering the election.
Many 401(k) plans are “boiler plate” plans, especially those for small employers. I think you will see plan sponsors come up with a simple amendment now the Roth option is permanent. From a bookkeeping point of view, its just a couple of line item alterations. All in all, I would predict the Roth option to gradually become more available.
2. If your 401(k) plan has an employer match, the match must be allocated to the regular 401(k) plan.

 

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This entry was posted on Thursday, March 1st, 2007 at 12:42 am and is filed under Financial, General, Investing.