Roth 401k Plans compared to the Traditional 401k


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Choosing Between Traditional and Roth 401k's

Roth 401k plans are a relatively new retirement option. However, like most retirement plans, they are a great fit for some retirement savers, but no so much for others. Like a Roth IRA, contributions are after tax and participants may make withdrawals free of taxes and penalties after age 59 1/2.

Traditional and Roth 401ks

Roth 401k plans are attractive to employees willing to forego a pre-tax deduction now in return for getting one at retirement. In a nutshell, the Roth 401k combines features of a traditional 401k with those of a Roth IRA.

Roth 401k plans are similar to a traditional 401k, where workers enjoy the convenience of contributing through payroll deductions. However, like a Roth IRA, contributions are made on an after-tax basis and withdrawals after age 59 1/2 are tax-free and penalty-free for workers who have maintained their account for five years.

How a Roth 401k Works

The Roth 401k follows many of the same rules as a traditional 401k. For the 2006 tax year, federal laws permit a maximum annual contribution of $15,000, although your employer may impose a lower limit. Your employer may provide a matching contribution as part of a Roth 401k offering, although you will be required to accept the matching contribution in a traditional, and not a Roth, account. If you are age 50 or older, you may contribute an additional $5,000 for a total of $20,000 in 2006.

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You may continue to maintain a traditional 401k while directing all or a portion of new contributions to a Roth 401k. However, workers forgo the right to commingle the funds if they ever wanted to pursue the option.

Planning for Retirement using a Roth 401k

A Roth 401k may present a significant benefit when it's time for retirement. The funds can be rolled over directly to a Roth IRA with no tax payment, a feature that is currently not available with a traditional 401k account. A traditional 401k must first be rolled over to a traditional IRA and the traditional IRA then converted to a Roth IRA.

Roth vs. Traditional 401ks: A Quick Comparison

To Roth or Not to Roth?
  • Although future tax rates are difficult to predict, you may benefit from a Roth 401k or 403(b) if you anticipate being in a higher tax bracket during retirement.

  • Will you need your retirement assets for living expenses during your later years? If not, a Roth 401k offers the opportunity to roll over funds directly to a Roth IRA, which does not require distributions after age 70 1/2. This situation may enhance the potential tax-free growth of your assets and enable you to bequeath a larger portion of your assets to your heirs.

  • You are not required to meet income thresholds to participate in a Roth 401k. Roth IRAs are limited to single taxpayers with $110,000 and married couples with $160,000 or less in adjusted gross income. A Roth 401k may have some appeal if you desire tax-free withdrawals but your income exceeds the threshold for a Roth IRA.

    As you can see, individuals saving for retirement have a great new option in a Roth 401k plan. However, as with most investing strategies, due diligence should be exercised to make sure that the Roth 401k is the correct plan for you.

  • The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

    This article appears in: Personal Finance , Retirement

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