Effective January 1, 2006, 401(k) plans now have the option to offer Roth 401(k)s. The Roth 401(k) is patterned after the Roth individual retirement account (IRA) - contributions are made from after-tax earnings that grow tax free and qualified distributions are withdrawn tax free. However, there are some significant differences between Roth 401(k)s and Roth IRAs:
Employees eligible for their employer's 401(k) plan are also eligible for a Roth 401(k). There are no income limitations for contributing to a Roth 401(k). With a Roth IRA, single taxpayers with adjusted gross income (AGI) less than $95,000 and married taxpayers filing jointly with AGI less than $150,000 can make contributions, regardless of their participation in a qualified retirement plan. Contributions are phased out for married taxpayers filing jointly with AGI between $150,000 and $160,000 and for single taxpayers with AGI between $95,000 and $110,000.
The contribution limits for the Roth 401(k) are the same as for a regular 401(k) plan. In 2006, you can contribute a maximum of $15,000 plus a $5,000 catch-up contribution for those age 50 and over, if permitted by your plan. However, your employer may set lower limits than this to comply with nondiscrimination rules. Contributions can be split between a regular and Roth 401(k), as long as total contributions do not exceed the maximum, with funds held in separate accounts. Any matching contributions made by the employer must be made to the regular 401(k) account, so they will be taxable when withdrawn. In 2006, the contribution limits for a Roth IRA are $4,000 plus an additional $1,000 catch-up contribution for individuals age 50 and over. You can make contributions to both a Roth 401(k) and a Roth IRA, as long as you meet the income eligibility rules for the Roth IRA.
- Required distributions
With a Roth IRA, you are not required to take distributions during your lifetime. Thus, it is typically seen as a good estate planning vehicle for individuals who want to leave tax-advantaged assets to heirs. With a Roth 401(k), annual distributions must be taken after age 70 1/2. However, funds in a Roth 401(k) can be rolled over to a Roth IRA, which would not require distributions.
Individuals under certain income levels can convert a regular IRA to a Roth IRA, as long as income taxes are paid on the amount that would have been taxable if withdrawn. There is no provision to convert regular 401(k) accounts to Roth 401(k)s.
Like many recent tax provisions, the Roth 401(k) is scheduled to expire after 2010, unless further legislation is passed.