Simple advices about Roth 401k Plan Provisions

Overview of Roth 401k

Roth 401k is simply another choice for 401k plans. It allows participants to defer after-tax salary dollars. Contrast this to traditional 401k salary deferrals – which have been on a pre-tax basis. Roth 401k is an optional feature that employers can add to a plan, but employers are not required to do so.

Roth 401k Basics

In very general terms, Roth 401k money is “after-tax” money. Like a traditional IRA, earnings within the account are not taxed each year. However, Roth 401k money is unique in that qualifying withdrawals are not subject to ordinary income-tax. This means that if you follow all of the IRS rules, the money you take out of a Roth 401k at retirement is tax-free. Of course there are tradeoffs and pitfalls, which you should carefully study before choosing.

Roth 401k Limits

The contribution limits for Roth 401k dollars will be the same as those for traditional 401k contributions. In 2006, the maximum salary deferral limit is $15,000, with an additional $5,000 catch-up provision available to those over age 50.

Combining Money-Types

Employees may be able to mix how a plan characterizes salary deferrals (if their plan allows it). For example, an employee could say “I want 60% of my deducted pay to be Roth 401k money, and the rest to be pre-tax money”.

Roth 401k – Employee vs. Employer Dollars

The Roth 401k is only available for employee deferrals. In other words, an employee’s salary deferral (or paycheck deduction) can be characterized as Roth-type. However, employer money (matching contributions, profit sharing, and so on) will not be part of Roth 401k.

Roth 401k Timeline

Plans may begin deferring after-tax dollars starting January 1st 2006. However, it is likely that some plans will not offer the feature at that time. Possible reasons for delay are:

At the end of 3rd quarter 2005, the IRS had not issued final regulations and guidance on Roth 401k

Plan providers (investment companies) may not be ready to administratively handle Roth 401k accounting

Employers may not have fully analyzed the tradeoffs involved in offering Roth 401k

There are a variety of other reasons that may hold up the implementation of the Roth feature for a 401k plan. Remember, the employer may offer Roth 401k, but is not required to. In addition, some plans may only offer a portion of what is allowed under Roth 401k rules. The rules say they are allowed to do this, not that they must.

Roth 401k Sunset

Roth 401k may not be around forever. The laws that allowed Roth 401k were part of EGTRRA, and the rules that allow Roth 401k “sunset” (or end) in 2011. This means that Congress would need to take action before 2011 for the provisions to become permanent. There is no guarantee that they will do this, so we will have to wait and see.