The individuals who have contacted me, all in their 50s, are in the 25% and 28% federal tax brackets and work in New Jersey or New York, which have high state income taxes and, like “Sam”, treat 401(k) contributions as “pre-tax”. This means that 30-35% of the money they have been contributing to a traditional 401(k) has been paid for by their “uncles”. With the maximum 2007 contribution at $20,500 this means that electing to put all their money in a ROTH 401(k) will cost between $6,000 and $7,000+ in tax savings. This is a substantial amount of money – an amount that most cannot necessarily afford or want to give up in exchange for future tax savings.
Due to their age they have already built up a sizeable balance in their traditional 401(k) accounts – such that the Required Minimum Distribution they will be withdrawing at age 70½ will be most likely be more than enough to cover their retirement living expenses.
As I have pointed out to those who have contacted me, the main reasons for a person in their situation contributing to a ROTH 401(k) are:
(1) to reduce your required minimum distributions at age 70 ½, and, perhaps more important,
(2) to pass your ROTH monies on to your beneficiaries tax free.
Younger employees just starting out, or who have only been contributing to a traditional 401(k) for a couple of years or have been contributing only a small amount each year, should certainly take advantage of the ROTH 401(k) option if offered. Assuming Congress does not muck up the ROTH down the road, they will reap huge benefits when they retire.
Older employees, like those whom I have described above, may want to put a small portion of their maximum contribution, say $1000 or $2000, into a ROTH account and put the rest in the traditional account.
Here’s an idea. If 2007 is the year in which you will turn 50 and you intend to contribute the full $15,500.00 “normal” amount and, for the first time, the $5,000.00 additional “catch-up” amount to your 401(k) - put $15,500.00 in the traditional account and $5,000.00 in a ROTH account.