Now I CAN Have A Roth! The New Roth 401(k) Option – Ask Your Employer About Your Options
Now I CAN Have A Roth! The New Roth 401(k) Option – Ask Your Employer About Your Options
When IRA administrators talk to clients about the Roth IRA, the conversation often starts with excitement but ends with disappointment. Many clients discover that they are not eligible for a Roth contribution because they make too much money. Moreover, another set does not meet the even more stringent requirements for conversion of a traditional IRA into a Roth. Those that are eligible find that the maximum contribution seems so small it is hardly worth the effort. Soon these conversations will be ending on a much happier note.
One of the last changes resulting from the 2002 revision of tax laws came into action on January 1, 2006. The Roth 401(k) option, available for those plans adopting it, provides the employee the option to defer their “employee deferral” contribution to the 401(k) plan into a Roth type account. The contribution is entirely elective to the employee and is NOT subject to the income limits in place for Roth IRA contributions! Every employee participating in a 401(k) plan offering the election may now have a Roth type contribution.
For those of you who filed the facts related to the Roth IRA under “Too Good to Be True” in the circular file, here is a quick refresher:
Contributions made to a Roth are not deductible, but distributions from Roths are generally tax-free. Special rules apply if you are under 59 ½ when you take the distribution, but the tax- free option can be available even then.
Even though you don’t get a deduction currently, you are effectively prepaying tax on income in the future. Which is better for you? It is always a personal decision, based in big part on what is going to happen in your financial future. Many taxpayers conclude that paying the tax now on a smaller amount is better than paying on larger amounts somewhere in the future. Especially if they can afford to pay the tax currently, thus resulting in more money in the retirement account.
Another big advantage of the Roth is that the minimum distribution rules do not apply. Therefore, if you don’t need the money for retirement, you can keep it growing tax free in the account as long as you want, even after age 70 ½. You may also pass the account on to your beneficiaries tax-free so they don’t have to cash a big chunk of it in to pay the income taxes on it.
Since 1998, Roth IRAs have been available but not eligible for many taxpayers due to income limits imposed that phase out contributions and limit conversions. Even for those who could contribute, the maximum contributions of $4,000 or less have seemed puny compared to contributions available through company plans of up to $42,000.
With the new Roth 401(k), contributions will be available to all participants, regardless of gross income, and maximum deferral amounts will be $15,000 or $20,000 for those ages 50 or over. The other Roth rules, as described above will apply. Company match and voluntary contributions to the plan will remain tax deferred as they are currently. No conversion provisions are currently available to convert old 401(k) deferrals to Roth 401(k)s.
Since the plan will require some additional recordkeeping, some employers might not be excited to adopt the new Roth option. Talk to your plan administrator and encourage them to offer the new option as soon as possible if you see potential benefits. For those employers operating with the Entrust prototype plan, it has been revised to provide the Roth option as an election on January 1, 2006.
Those individuals with small companies or who are self-employed and who now provide a SEP plan for their employees and themselves may wish to revisit the possibility of adopting a qualified plan with the Roth 401(k) option as a valuable alternative.
Bill Humphrey, a Colorado CPA, is Principal of Entrust New Direction IRA, Inc. Marketing to Colorado, Montana, and Wyoming
http://www.NewDirectionIRA.com
http://www.IRS.gov
http://www.DOL.gov/ebsa