The Roth 401k plan option
The Roth 401(k) can offer advantages to high-income individuals who haven't been able to contribute to a Roth IRA because of the income restrictions. (Eligibility for 2009 phases out between $105,000 and $120,000 for single filers and $166,000 to $176,000 for those who are married and file jointly).
Roth 401(k) accounts are subject to the contribution limits of regular 401(k)s - $16,500 for 2009, or $22,000 for those 50 or older by the end of the year - allowing individuals to stock away thousands of dollars more in tax-free retirement income than they would through a Roth IRA. (In 2009, Roth IRA contributions are limited to $5,000 a year, or $6,000 for those 50 or older.)
The hitch: Those limits apply to contributions to both types of 401(k) plans, so participants can't save $16,500 in a regular 401(k) and another $16,500 in a Roth 401(k). Employees who are offered this option face a difficult choice: Contribute to a Roth 401(k) and suffer a cut in take-home pay (since contributions are made with after-tax dollars), or stick with a traditional 401(k) and hope that in retirement, their tax rate will be lower than it is now. Alternatively, they could hedge their bets by contributing to both accounts.
If the employee expects tax rates to be the same or higher in retirement than it is now, he or she might be better off with a Roth 401(k). This is likely to be the case with young people who are just starting their careers and expect their income to increase in the future. If the employee is in peak earning and anticipates his or her tax bracket will be lower in retirement, then continuing to use a traditional 401(k) is probably the best option. In reality, of course, things are much more complicated. For one, no one can predict with certainty what tax rates will be in the future, though the general consensus is that they're likely to rise to help the government offset growing budget deficits and pay for Social Security and Medicare.
No mandatory withholding for in-plan conversions of 401(k)s to Roth Rollovers. Plan sponsors who are allowing direct Roth rollovers from 401(k) and 403(b) plans into Roth Rollovers don’t have to worry about mandatory withholding for those “distributions.” According to a notice posted by the Internal Revenue Service on its website, mandatory 20% withholding does not apply to in-plan Roth direct rollovers.
"In-Plan Rollovers" to Designated 401k Roth Accounts
A 401k plan with a designated Roth program can allow rollovers to a designated Roth 401k account from another account in the same plan (an "in-plan Roth rollover").
Any vested plan balance, including earnings, can be rolled over to a designated Roth account. The amount doesn't have to be eligible for distribution; however, the rollover must be direct (not a 60-day rollover) if the amount is not otherwise eligible for distribution.
The plan participant (employee), surviving spouse beneficiary, or alternate payee who is a spouse or former spouse can elect an in-plan Roth rollover.
An in-plan Roth 401k rollover usually results in taxable income to the participant. A typical rollover from a pre-tax account will result in the entire amount of the rollover, including earnings, being included in gross income. The amount includible in gross income for the year of the rollover is the amount rolled over, less any basis in the amount transferred. The additional 10% early withdrawal tax doesn't apply to the amount of an in-plan Roth rollover. However, the distribution may be taxable and subject to the additional early withdrawal tax if the participant withdraws it from the designated Roth account within five years.
An in-plan Roth rollover cannot be reversed after the transfer is made. The rolled over amounts can't later be returned to the transferring account. This treatment is different from rollovers to a Roth IRA, which may be re-characterized within a certain time limit.
A direct rollover to a designated Roth 401k account is generally treated as a distribution followed by a transfer to the Roth account, but a plan loan transfer isn’t treated as a new loan and spousal consent isn't required.
|Traditional 401(k) Contributions||Roth 401(k) Contributions|
|When you will pay taxes on your contributions||You pay the tax upon withdrawal. Contributions are tax-deferred, so current taxes are reduced.||You pay regular income tax on your contributions before the money goes into your account. Current taxes are not reduced.|
|When you will pay taxes on any investment earnings||You pay taxes on the full amount of any distribution, including earnings, at ordinary income tax rates in effect upon withdrawal.||Your contributions have already been taxed, so there is no tax on them and no taxes on any earnings if you take a qualified distribution.|
|Qualified distribution rules*||Contributions and any earnings remain in account until age 591/2 or a separation from service that qualifies for retirement distributions. Withdrawals are subject to current ordinary income tax at withdrawal (and a 10% tax penalty may apply before age 591/2) unless the tax deferral is continued.||Contributions and earnings are distributed tax-free if they meet the requirements of a qualified distribution; earnings in a non-qualified distribution are subject to current ordinary income tax (and a 10% tax penalty may apply before age 591/2) unless the tax deferral is continued.|
|Impact of contributions on take-home pay||Since contributions are pre-tax, your current income tax is reduced and each $1 contributed reduces your take-home pay by less than $1.||Because you pay current taxes on your contributions, take-home pay is reduced dollar for dollar by your contributions.|
|Rollovers from your account||You may roll over your account balance upon termination to a traditional IRA, a 401(k) plan or another qualified employer-sponsored plan.||You may roll over your account balance upon termination to a Roth IRA or another Roth 401(k) or Roth 403(b) account in a qualified employer plan.
Note: For purposes of the 5-year rule for qualified distributions, the date of the initial contribution to a Roth IRA governs.
|Taxes on employer match, if applicable||Employer matching contributions are made on a pre-tax basis; contributions and any earnings are taxable upon withdrawal.||Same. The employer match is not treated as a Roth contribution.|
|Required minimum distributions||You must begin required minimum distributions by April 1 of the year following the year in which you reach age 701/2 or at retirement, if later.||You must begin required minimum distributions by April 1 of the year following the year in which you reach age 701/2 or at retirement, if later.|
|Loan and hardship||Account balances are available for 401(k) loans and hardship withdrawal if the plan allows.||Contributions are available for 401(k) loans and hardship withdrawal if the plan allows.|
* For purposes of qualified distributions, disability must meet the definition stated in Internal Revenue Code Section 72(m) (7).