Understanding the Roth 401k Retirement Plan

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The Roth 401k

Effective January 1, 2006, businesses looking for an employee retirement plan had a new option: the Roth 401k. If the name sounds familiar, that's because it is. The Roth 401k combines the Roth IRA's power of tax-free withdrawals with the flexibility and investment options of a traditional 401k plan. 

Roth 401k Plan Advantages

The Roth 401k plan offers advantages to high-income individuals who haven't been able to contribute to a Roth IRA because they make too much money. (Roth IRA eligibility for 2010 phases out between $105,000 and $120,000 for single filers and $167,000 to $177,000 for those who file jointly). A Roth 401k has no income restriction.

Another advantage of a Roth 401k plan is that they have the same contribution limits of regular 401ks - $16,500 for 2010, or $22,000 for those 50 or older by the end of the year, allowing plan participants to stock away thousands of dollars more in tax-free retirement income than they would through funding a Roth IRA. (In 2009, contributions to a Roth IRA are limited to $5,000 a year, or $6,000 for those 50 or older.)

In addition, participants can continue making contributions to existing or new Roth IRA accounts while investing in a Roth 401k. Keep in mind a Roth 401k isn't an opportunity to circumvent IRS regulations and double your annual contributions. You're allowed to maintain both traditional and Roth versions of a 401k, but you can only contribute up to the annual limit for both plans combined.

If an employer decides to offer a Roth 401k and they match employee contributions, the amount contributed to the plan are still made with pretax dollars. They are kept in a separate account and taxed when the money is taken out. 

 

 

Other Similarities to a traditional 401k

  • Rollovers are permitted 
  • Participants can begin withdrawing funds after 59½ 
  • Participants are required to withdraw funds after 70½ 
  • Employees can leave your company and keep vested funds in your plan but can't make further investments 
  • Withdrawing funds early incurs a 10% penalty and taxes on any potential gains 
  • If you permit loans, participants can withdraw funds but must have a qualifying event (retirement, termination of service, financial        hardship) 

What does the future hold for Roth 401k? 

Roth 401k plans are still in their infancy so it's too soon to determine how it will evolve over the years. After 2010, the Roth 401k option was goin to expire , but legislation in 2006 took steps towards making the plan permanent. Therefore, it appears that the Roth 401k plan is here to stay.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Personal Finance , Retirement

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