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
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.
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
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.