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Pinnacle Resource Center Is the Roth 401(k) Right For Me? The Roth 401(k) is a new investment option that went into effect on Jan. 1. This article will help you understand this new investment option and whether it should be part of your portfolio. Roth 401(k) Background The Roth 401(k) combines features of a traditional 401(k) plan with features of a Roth IRA. With the new Roth 401(k) option, you do not get a pre-tax benefit for contributions, but the money is sheltered from taxes for life, much the same way as a Roth IRA. When you withdraw that money during retirement, you will not owe any income taxes. Distribution must begin by age 70 ½ unless rolled to a Roth IRA (this rule is subject to change by the IRS). Under the traditional 401(k) option, you contribute money from wages before federal taxes are taken out. The invested money is then sheltered from taxes until you draw down the investment during retirement. At that point, the federal government takes its share by imposing income taxes. Unlike Roth IRAs, the Roth 401(k) does not have income limits or qualifications, making it an attractive option for high-earning professionals. Last year, a married couple filing jointly could contribute $4,000 each to a Roth IRA only if they earned less than $150,000. Above that income, the contribution amount gradually shrinks with higher income before qualification ends at $160,000. Roth 401(k) Tax Advantages In general, a Roth 401(k) makes sense for high-income earners and younger individuals in a lower bracket now who will be in a higher tax bracket when they retire. Over a ten-year period, the net income from a Roth 401(k) is a better investment option than a traditional 401(k). There is no difference between a Roth 401(k) and a traditional 401(k) as long as the tax rate during retirement is the same as the rate during the contributing years. Right Combination for You If your employer offers a Roth 401(k), you can choose to contribute only to a Roth option, only to a regular 401(k) or split contributions between both. The total contribution limit is $15,000 (or $20,000 if you are over age 50). The decision to add a Roth 401(k) to your investment mix will depend on several factors, including desired retirement income, estimated taxes during retirement and estate planning. Your sources of retirement income will obviously have a significant influence on the amount of your future taxes. Your financial advisor or tax planner can help you understand the tax implications of each choice. The Roth 401(k) may be an additional tool for estate planning because it is not subject to income taxes but is still subject to estate taxes. Required minimum distribution would not apply if rolled Roth IRA under the current IRS rules. By comparison, a beneficiary has to pay estate and income taxes on a traditional IRA or 401(k) that is part of an estate. Roth 401(k) faces a somewhat uncertain future. The Economic Growth and Tax Relief Reconciliation Act of 2001, the federal law that created the Roth 401(k), will expire Dec. 31, 2010. Judy Alexander, CFP®, is an Investment Consultant with Raymond James Financial Services located at 7040 Carothers Parkway in Franklin, Tenn. Judy can be contacted at 744-3754. Securities products and investment advisory services offered exclusively through Raymond James Financial Services, Inc., member NASD/SIPC, and are: Not FDIC Insured * Not Bank Guaranteed * May Lose Value Any opinions are those of Judy Alexander and not necessarily those of RJFS or Raymond James. |
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