Roth(k) Basics

Signed into law in 2001 (EGTRRA)

Available for first time in 2006

Optional feature that any 401(k) plan can offer

After tax contributions, tax-free earnings, tax-free withdrawals (if withdrawn after 5 years and past age 59 ½)

Available to both low and high-income employees (unlike Roth IRA)

Plans that permit Roth contributions must be amended by the end of the first year in which Roth money is allowed

Roth(k) Advantages

Provides tax-free income in retirement

Helps avoid tax on Social Security - Roth(k) withdrawals excluded from taxable income.

Has higher "effective" contribution limit than Traditional(k) since no tax is due when distributed from Roth(k)

Traditional(k) Advantages

Lowers taxable income today

May save tax breaks that "phase out" at higher income levels because pre-tax contributions lower your AGI (ex: For 2005, itemized deductions phase out at $145,950 single or joint AGI)

Contribution Rules

Roth and Traditional deferrals:
     - Have the same vesting rules, distribution restrictions (severance, hardship, age 59 ½, death, disability, plan termination), and minimum distribution requirements
     - Have one combined deferral limit
     - Are tested together in the ADP test
     - Are both eligible for employer match
     - Require separate recordkeeping accounts

A Roth(k) may be rolled over into another Roth(k) or a Roth IRA

A plan that distributes excess contributions (due to ADP test failure):
     - May allow HCEs who made both Traditional and Roth contributions to elect which type to return
     - If HCE elects Roth, excess contributions are returned tax-free (only earnings are taxable)

Contribution Rules (Not Allowed)

Allocating employer contributions to Roth accounts

Allocating forfeitures to Roth accounts

Converting Roth accounts to Traditional or vice versa

Roth(k) Withdrawal Rules

Contributions always come out tax-free

Earnings come out tax-free only if:
     - Age 59 ½, disability or death, AND
     - 5 years after starting Roth account

Which One Is Best?

Traditional(k) if your tax rate will be lower in retirement (pay taxes later)

Roth(k) if your tax rate will be higher in retirement (pay taxes now)

If your tax rate is the same now and in retirement, Traditional and Roth will produce same results

Roth(k) Will Appeal To Those Who:

Are young and in low tax brackets

Are well-off but view tax hikes as inevitable

Hope to avoid taxes on Social Security

Want to max out their contributions

Do not want forced distributions at Age 70 ½

Want to maximize assets left for heirs

Want to diversify with a mix of tax-deferred and tax-free retirement income

Issues To Ponder

Employee education

Impact on automatic enrollment

Impact on ADP testing