Since it first became available in 2006, many employers have added the Roth 401(k) to their benefit package as a retirement savings option. A Roth option, which is available for Individual Retirement Accounts (IRAs), as well as sponsoring 401(k) and 403(b) accounts, may be appropriate for some individuals, depending on their circumstances. So, is a Roth 401(k) right for you? Let’s take a closer look.

To Roth or Not to Roth
In order to decide whether the Roth 401(k) option has a place in your retirement plan, it is important to weigh the advantages and disadvantages of both types of 401(k)s. With a traditional 401(k), you make contributions on a pre-tax basis, which lowers your current taxable income, and earnings are tax-deferred. However, your retirement distributions will be subject to ordinary income tax. With a Roth 401(k), your contributions are not tax deductible, but earnings and distributions are tax free, provided you have held the account for at least five years and are at least 591⁄2 years old. Is it better to pay taxes on your retirement funds now or later? The most appropriate choice depends on your current tax situation and your long-term financial goals.

It is important to keep in mind that the 401(k) annual deferral limits—$16,500 for taxpayers under the age of 50 and $22,000 for those over age 50 in 2009—apply to all 401(k) contributions, regardless of whether they are made on a pre-tax or post-tax basis. If you contribute to a Roth 401(k), you may have to reduce or discontinue your contributions to your employer’s conventional 401(k) plan to avoid exceeding these limits. However, you may contribute to both types of 401(k) plans.

Also, matching contributions made by employers must be invested in a traditional 401(k), not a Roth account. So, even if you make contributions exclusively to a Roth 401(k) account, you will still owe tax in retirement on withdrawals from funds contributed on a pre-tax basis by your employer.

What about the Roth IRA?
The Roth 401(k) is only available through an employer-sponsored plan, whereas the Roth IRA is available to all taxpayers (with income limitations). How do the two Roth options compare? First, you can save more money in a Roth 401(k) than in a Roth IRA. The 2009 annual contribution limits for IRAs of all kinds are set at $5,000 for taxpayers under the age of 50 and $6,000 for older workers. The Roth 401(k) is subject to the more generous elective salary deferral limits that apply to conventional 401(k)s—$16,500 or $22,000 for those over age 50 in 2009.

Furthermore, the Roth IRA is subject to adjusted gross income (AGI) limits; only those with AGIs below $120,000 for single filers and $176,000 for joint filers are eligible to contribute after-tax dollars to a Roth IRA in 2009. These income limits do not apply to Roth 401(k)s.

In addition, contributions to a Roth 401(k) can be made through payroll deductions, which puts retirement saving on autopilot. To participate, an employee who is currently contributing to a traditional 401(k) plan could, for example, opt to have his or her contributions diverted to a Roth version of the same plan. Unlike the Roth IRA, however, you must begin taking required minimum distributions (RMDs) from a Roth 401(k) after the age of 701⁄2.*

If a Roth 401(k) makes sense for you, ask your company’s benefit administrator if the feature is available for your retirement plan. If it is not already in place, expressing interest in the Roth feature may increase the likelihood that your company will adopt the option.

* The Worker, Retiree, and Employer Recovery Act of 2008 suspends the rules governing 2009 RMDs from qualifying retirement plan accounts.

Current tax law is subject to interpretation and legislative change. Tax results and the appropriateness of any product for any specific taxpayer may vary depending on the particular set of facts and circumstances. The information contained in this newsletter is not intended as tax, legal, or financial advice, and it may not be relied on for the purpose of avoiding any Federal tax penalties. You are encouraged to seek such advice from your professional advisors. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Written and published by Liberty Publishing, Inc. Copyright © 2009 Liberty Publishing, Inc.