The enactment of EGTRRA also allowed for the creation of employer sponsored ROTH plans. These plans allow participants to make after-tax contributions to their 401(k) plan (if the employer adopts the ROTH) that will provide tax free qualified withdrawals.
Roth 401(k) Plans
Beginning in 2006, employers are able to establish ROTH 401(k) plans for their employees. Recent legistation has extended the ROTH 401(k) beyond 2010 when the program was originally planned to sunset. If your employer does not have a ROTH 401(k), consult your Human Resources department. They are generally easy to add-on to the current plan.
Unlike ordinary 401(k) plans, ROTH 401(k)'s are funded with after-tax employee elective deferrals. Employees can generally opt to participate in both the 401(k) as well as the ROTH 401(k) so long as the cumulative deferral to both plans does not exceed the 415 limits. Though ones' Adjusted Gross Income (AGI) can prevent them from making a contribution to a ROTH IRA, ROTH 401(k) plans have no such restriction. Your income does not affect eligibility to contribute to your employers ROTH 401(k). Distributions from ROTH 401(k) plans are typically tax-free for qualified withdrawals, as long as the withdrawal is at least 5 years after the first ROTH contribution.
Who should use a ROTH 401(k)?
As a general rule of thumb, ROTH contributions (both ROTH IRA and ROTH 401(k)) are most beneficial for:
1. people who are currently in a lower tax bracket but expect to be in a high tax bracket at retirement, or
2. people who have excess cash to invest and either do not need the effective tax deduction of traditional IRA and 401(k) contributions or do not qualify for deducting their Traditional IRA contribution.
What is the advantage of a ROTH 401(k)?
Again, ROTH 401(k) contributions are after-tax and therefore, do not reduce your gross income like ordinary 401(k) contributions. However, a young worker contributing to a ROTH 401(k) over 20, 30 or even 40 years could have a sizeable retirement nest egg awaiting them - tax-free. If you are unsure whether you should contribute to a ROTH 401(k) or your company's ordinary 401(k) plan, consult your financial advisor or CPA.