Most companies offer 401(k)s as their main retirement plan. Starting this year, 2006, there is a Roth option available for the 401(k). Even though the legislation for the plan was passed in 2001, this is the first year that the Roth 401(k) (the 403(b) also has a Roth option now) is in effect. You can take advantage of the Roth rules until the end of 2010, when they will expire unless legislative action is taken.
What is a Roth 401(k)?
The Roth 401(k) is basically a hybrid retirement plan. It takes some of the characteristics of the traditional 401(k) and combines them with some of the characteristics of a Roth IRA. Some, or even all, of an employee contribution to a Roth 401(k) is treated the same as contributions to a Roth IRA. This means that the contributions are not pre-tax. However, it also means that your Roth 401(k) money grows tax-free, and some of the withdrawals are tax-free.
Traditional 401(k) v. Roth 401(k)
For some people, the Roth 401(k) has greater value. If you contribute the same amount of money into one of each of the accounts, you will find that taxes on withdrawals from a regular 401(k) significantly reduce the value. This is because the pre-tax contributions to a traditional 401(k) grow tax-deferred. You may not have to pay taxes on them up front (and you might even get a deduction), but when you withdraw from your retirement account, you will have to pay taxes. So, even though you get no deduction for a Roth 401(k), and you have to pay taxes before the money is contributed to the retirement plan, your Roth 401(k) retirement account grows tax-free, and builds greater value when it comes to withdrawing.
Advantage over Roth IRA
The Roth IRA has with it some frustrating adjusted gross income (AGI) limitations. If you make more than a certain amount of money, you cannot take advantage of the Roth considerations. However, the Roth 401(k) does not have those AGI restrictions. Even if you have a higher income, it is possible for you to take advantage of the tax benefits offered through a Roth retirement plan. However, you should note that if you have a traditional 401(k) and a Roth portion, the combined limit is $15,000 for people under 50 and $20,000 for people over 50. You cannot separate the contribution limits out into two separate yearly contributions of $15,000 (or $20,000).
Does your employer offer the Roth 401(k) option?
As with most retirement plans, the Roth 401(k) is offered at employers´ discretion. An employer does not have to offer a Roth 401(k) option in the company benefits plan. Check with your employer to see if a Roth option has been added to the 401(k) retirement account plan, and if it has not, ask if perhaps it could be. There is a great opportunity to take advantage of a retirement plan that combines some of the attractive features of a traditional 401(k) with the excellent tax benefits of a Roth IRA.
You can read more about the Roth 401(k) here.