The ROTH IRA was created by the Tax Reform Act of 1997 and has been available since 1998. While similar to the “traditional” IRA in several ways (such as the contribution limitations, penalty for excess contributions, prohibition against pledging the assets of the account as security or borrowing from the account, and restrictions to the type of assets that can be contributed to and held in the account) it has several unique features that make it “more better”.
· Contributions are not deductible.
· You do not have to take “required minimum distributions” upon reaching age 70½ - you never have to take any distributions during your lifetime.
· You can continue to contribute to the account once you reach age 70½ for as long as you have earned income.
· “Qualified distributions” are totally tax free.
· Only the earnings portion of a premature withdrawal is subject to the 10% penalty.
· While ROTH IRA accounts are included in the decedent’s taxable estate, beneficiaries are not subject to income tax on distributions from an inherited ROTH.
The Economic Growth and Tax Relief Reconciliation Act of 2001 extended the ROTH concept to the employer sponsored 401(k) plan. Effective with tax years beginning on or after January 1, 2006, employer’s can elect to offer 401(k) participants a ROTH option.
While contributions to “traditional” 401(k) plans are considered “pre-tax”, ROTH 401(k) contributions are made with “after-tax” dollars. Contributions to a ROTH 401(k) will not reduce the amount of taxable wages reported on Box 1 of your Form W-2. But, like the ROTH IRA, qualified distributions from a ROTH 401(k) will be totally tax free.
For 2006 you will be able to contribute up to a total of $15,000.00 to any combination of a traditional 401(k) and a ROTH 401(k) - the maximum is $15,500.00 for 2007 - plus an additional $5000.00 if you will be age 50 or older on December 31st. For example, you can elect to put half into a ROTH and half into a traditional. Any company match will continue to go into the traditional 401(k).
While the ability to contribute to a ROTH IRA is phased out if your AGI exceeds a certain amount, there are no income limitations for a ROTH 401(k). Anyone who is eligible to participate in a traditional 401(k) plan can also participate in a ROTH 401(k) plan, regardless of income, providing your employer offers such an option.
Unlike the ROTH IRA, you must take distributions from your ROTH 401(k) account beginning within 6 months of turning age 70½. However, upon leaving your employer you can roll over the balance in your ROTH 401(k) to a ROTH IRA and never have to touch the money.
Why would you want to opt for a ROTH 401(k)?
· You do not rely on the tax savings from your “pre-tax” 401(k) contributions to balance your budget.
· You are young and plan to keep your money in your 401(k) plan for a long time.
· Your Adjusted Gross Income is too high for you to be able to open a ROTH IRA account.
· You will have more than enough savings accumulated in a various accounts for your own retirement needs. You want to reduce the amount of your annual required minimum distributions, and you want to be able to pass as much of your retirement plan money as possible tax-free to your beneficiaries.
Like everything in EGTRRA 2001, the ROTH 401(k) was scheduled to “sunset” at the end of 2010. This did not mean that your ROTH 401(k) account would suddenly become taxable – just that you would no longer be able to make additional contributions after 2010. However, the Pension Protection Act of 2006 has made the ROTH 401(k), and its sister the ROTH 403(b), permanent.
While the law allows employers to offer employees a ROTH 401(k) option, the employer must elect to institute such a plan. When it was thought that the ROTH 401(k) would only have a 5-year life employers were reluctant to offer such plans, considering the amount of paperwork involved. Perhaps now that it is permanent more employers will be making the option available to its employees.
A good source of information on the subject is the ROTH 401(k) Web Site.