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Are Roth 401(k) Contributions Right For You?Starting in 2006, your 401(k) plan might be offering you a new contribution option. On January 1, employers that sponsor 401(k) salary deferral retirement plans can begin allowing plan participants to make Roth contributions. Roth contributions present plan participants with additional flexibility in their retirement planning and could result in more spendable dollars for retirement.Background With traditional 401(k) pretax deferrals, the contributions come out of a participant’s pay before federal (and, in most cases, state) taxes are paid. These pretax contributions, plus any plan earnings on the contributions, are tax deferred until they are distributed from the plan, usually at or during retirement. Then, all of the pretax contributions, plus earnings, are taxed to the recipient at ordinary income-tax rates.Unlike traditional pretax deferrals, Roth contributions are taxable at the time the contribution is made. However, if tax law requirements are met, no taxes are due on the Roth contributions or any plan earnings when money is distributed from the plan. In other words, any earnings on the Roth contributions are completely income-tax-free.
Requirements To qualify for tax-free treatment, Roth distributions (1) must be made more than five years after the first Roth contribution is made to the plan and (2) may be made only when the participant is age 59˝ or older, is disabled, or dies.For 2006, total elective deferrals to a 401(k) plan – traditional pretax or Roth – are limited to $15,000 ($20,000 for those who are age 50 or older). The limit applies whether you make pretax contributions only, Roth contributions only, or a combination of the two. Note that employers are not required to offer Roth contributions and, even if the plan does offer them, participants are not required to make them. Note, too, that Roth contributions are a limited time offer – the tax law authorizing them expires after 2010, unless it is extended. And, finally, 403(b) annuity plans (offered, generally, by educational institutions and other tax-exempt organizations) are also eligible to offer employees a Roth contribution option. Which Type of Contribution Is Best? Deciding whether Roth contributions are right for you can be complicated, since the answer may differ depending on your assumptions about your future. The factors you need to consider include: your current age, your expected retirement age, your current tax rate, your expected tax rate at retirement, and the amount of your ongoing plan contributions.For some people, paying taxes now on their contributions and having tax-free benefits when they retire will be more beneficial. For others, making pretax contributions now and paying taxes later could result in a larger after-tax accumulation. The decision is not the same for everyone, and which contribution type provides the biggest advantage for you depends on your individual situation. We Can Help If your employer will be offering you the “Roth 401(k)” option, you will have an important decision to make. Our professionals are knowledgeable about both types of 401(k) contributions and can help you determine which type – pretax or Roth – is best for you. We can review your situation with you and provide you the analysis you need to make the decision that fits your circumstances and desires. Contact us today to find out more.The information provided in the newsletter has been obtained from sources believed to be reliable but its accuracy is not guaranteed. |