Ask Your Employer About New Retirement Option
Surveys show young workers receptive to new type of retirement plan, but will
employers adopt this short-lived option, scheduled to expire in 2010?
There’s a new kind of defined retirement plan on the market, but you may have to ask your employer to
add it to your current plan.
In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRAA), which
provided a variety of changes, adjustments and extensions to rules for retirement plans to be phased in
during the ensuing 10 years. Among those provisions was the creation of the Roth 401(k), a hybrid that
allowed contributions of after-tax dollars (like a Roth IRA) through salary deferral up to $15,000 (2006
limit) with a $5,000 catch-up allowed for people over age 50 (like a 401(k) plan.)
Roth 401(k) plans haven’t received much attention in the intervening years because that particular part of
EGTRRA didn’t take effect until January 2006. Most employers, according to a survey by Hewitt
Associates, have not yet added the Roth 401(k) to their retirement offerings,
and only one-third of companies say they are “very” or “somewhat” likely to
add it. Those who do, however, find the most Roth 401(k) fans among
workers in their 20s, 14% of whom select the new plans when offered, the
highest rate for all age groups.
That’s not surprising. Roth 401(k)s operate on the same assumption as Roth
IRAs: that those who use them will be in a higher tax bracket after retirement
than they are now. Both Roth products are funded with after tax dollars,
making withdrawals of contributions and earnings tax free. Traditional 401(k)s
and traditional IRAs work the opposite way: dollars are contributed pre-tax
or with an attached tax deduction now, and contributions and earnings are
taxed upon withdrawal, when the employee expects to be in a lower tax
Prior to May 2006, individuals earning more than $110,000 ($160,000 for
married couples), could not contribute to a Roth IRA. Individuals earning more
than $100,000 could not convert a Traditional IRA to a Roth IRA. These
income restrictions will be eliminated in 2010. Individuals who earn more
than $110,000 cannot open a Roth IRA, although many tax and investment
professionals expect the IRS to allow those over the income limit to open
Roth IRAs to receive rollovers from the Roth 401(k)s.
If Congress makes no effort to extend the lifespan of the Roth 401(k), those
funds will be eligible to roll into a Roth IRA. A rollover may also be beneficial
to someone turning 70½. At that age, Roth 401(k) accounts, traditional 401k
accounts and traditional IRA accounts begin minimum required distributions.
A Roth IRA has no mandatory distribution, so the money in them can continue
to grow tax-free for as long as you wish – even for the beneficiary of your Roth
Like Roth IRAs, Roth 401(k) contributions are subject to a five-year investment
requirement, meaning that to receive distributions without penalty, the account
holder must be age 59 ½ and have held the account for five years. When rolling funds from a Roth 401(k)
to a Roth IRA –or in any other conversion – keep careful records to verify the date you made the
contributions so you can establish the base for that five year holding period.
Many factors can affect your personal decisions about traditional versus Roth, and 401(k) versus IRA,
including your age, your tax bracket now, your expected tax bracket in retirement, the amount you are
contributing, and your ability and desire to pass funds to future generations. An investment professional
can help you weigh the pros and cons of each account and contribution type to determine which best
meets your needs.
If you are an employer, your investment and tax professionals can help you decide whether adding the
Roth 401(k) contribution provision to your plan – a relatively simple and low-cost change – makes sense
for you and your employees.
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