401k Easy - Roth 401k
The 401k Easy Roth 401k plan option
As the name implies, a Roth 401k combines features of the traditional 401k with those of the Roth IRA. The Roth 401k is offered by plan sponsors alongside a traditional 401k. Employees make contributions to the Roth 401k in addition to (or as an alternative to) making contributions to their traditional 401k. Unlike a traditional 401k contribution, which is always pre-tax, all Roth 401k contributions are made with the employee's after-tax dollars. As with the traditional 401k, the participant's Roth 401k contributions grow tax-free. But unlike traditional 401ks, withdrawals taken from the Roth 401k during retirement not subject to income tax, provided the account holder is 59 1/2 and the Roth 401k contributions have been held in the account for a minimum of five years.
The Roth 401k 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 401k accounts are subject to the contribution limits of regular 401ks - $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 401k plans, so participants can't save $16,500 in a regular 401k and another $16,500 in a Roth 401k. Employees who are offered this option face a difficult choice: Contribute to a Roth 401k and suffer a cut in take-home pay (since contributions are made with after-tax dollars), or stick with a traditional 401k 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 401k. 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 401k 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 401ks to Roth Rollovers. Plan sponsors who are allowing direct Roth rollovers from 401k 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.
*For purposes of qualified distributions, disability must meet the definition stated in Internal Revenue Code Section 72(m) (7).
The Roth 401k 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 401k accounts are subject to the contribution limits of regular 401ks - $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 401k plans, so participants can't save $16,500 in a regular 401k and another $16,500 in a Roth 401k. Employees who are offered this option face a difficult choice: Contribute to a Roth 401k and suffer a cut in take-home pay (since contributions are made with after-tax dollars), or stick with a traditional 401k 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 401k. 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 401k 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 401ks to Roth Rollovers. Plan sponsors who are allowing direct Roth rollovers from 401k 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.
More specifically, the IRS allows participants to make rollovers from their 401k and 403(b) plans to their designated Roth accounts (an "in-plan Roth rollover") after September 27, 2010. The taxable amount rolled over is includible in income equally in 2011 and 2012, unless the taxpayer elects to include it in 2010. The additional tax under section 72(t) does not apply to these rollovers.
The IRS says that the amount rolled over should be reported in box 1 (Gross distribution), the taxable amount in box 2a, and any basis in the rollover in box 5 (Employee contributions). Further, Code G in Box 7 on Form 1099-R should be used. The notice goes on to say that distributions made to plan participants in 2010 from designated Roth accounts must be reported on a separate Form 1099-R, and that the portion of a distribution from a designated Roth account that is allocable to an in-plan Roth rollover must be reported on a Form 1099-R. "Report the distribution as you would any other distribution from a designated Roth account; however, in the blank box to the left of box 10, enter the amount of the distribution allocable to the in-plan Roth rollover".
| Traditional 401k Contributions | Roth 401k 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 401k plan or another qualified employer-sponsored plan. | You may roll over your account balance upon termination to a Roth IRA or another Roth 401k 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 401k loans and hardship withdrawal if the plan allows. | Contributions are available for 401k 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).