Ask Your Employer About New Retirement Option
There’s a new kind of defined retirement plan on the market, but you may have to ask your employer to add it to your current plan.
In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRAA), which provided a variety of changes, adjustments and extensions to rules for retirement plans to be phased in during the ensuing 10 years. Among those provisions was the creation of the Roth 401(k), a hybrid that allowed contributions of after-tax dollars (like a Roth IRA) through salary deferral up to $15,000 (2006 limit) with a $5,000 catch-up allowed for people over age 50 (like a 401(k) plan.)
Roth 401(k) plans didn’t received much attention in the intervening years because that particular part of EGTRRA didn’t take effect until January 2006 and was set to expire at the end of 2010. It was made permanent by the Pension Protection Act of 2006. A survey conducted in early 2007 by the Profit Sharing/401(k) Council of America showed that 22 percent of 401(k) plans offered a Roth option, and 61 percent of plans were either considering or planning to add a Roth option.
That’s not surprising. Roth 401(k)s operate on the same assumption as Roth IRAs: that those who use them will be in a higher tax bracket after retirement than they are now. Both Roth products are funded with after tax dollars, making withdrawals of contributions and earnings tax free. Traditional 401(k)s and traditional IRAs work the opposite way: dollars are contributed pre-tax or with an attached tax deduction now, and contributions and earnings are taxed upon withdrawal, when the employee expects to be in a lower tax bracket.
In May 2006, Congress eliminated income restrictions, which were $110,000 for individuals and $160,000 for married couples, on conversions from traditional IRAs to their Roth counterparts. This provision, however, doesn’t kick in until 2010. Individuals who earn more than $110,000 cannot open a Roth IRA, although many tax and investment professionals expect the IRS to allow those over the income limit to open Roth IRAs to receive rollovers from the Roth 401(k)s.
A rollover may also be beneficial to someone turning 70½. At that age, Roth 401(k) accounts, traditional 401(k) accounts and traditional IRA accounts begin minimum required distributions. A Roth IRA has no mandatory distribution, so the money in them can continue to grow tax-free for as long as you wish – even for the beneficiary of your Roth IRA account.
Like Roth IRAs, Roth 401(k) contributions are subject to a five-year investment requirement, meaning that to receive distributions without penalty, the account holder must be age 59 ½ and have held the account for five years. When rolling funds from a Roth 401(k) to a Roth IRA –or in any other conversion – keep careful records to verify the date you made the contributions so you can establish the base for that five year holding period.
Many factors can affect your personal decisions about traditional versus Roth, and 401(k) versus IRA, including your age, your tax bracket now, your expected tax bracket in retirement, the amount you are contributing, and your ability and desire to pass funds to future generations. An investment professional can help you weigh the pros and cons of each account and contribution type to determine which best meets your needs.
If you are an employer, your investment and tax professionals can help you decide whether adding the Roth 401(k) contribution provision to your plan – a relatively simple and low-cost change – makes sense for you and your employees.
Barry Armstrong is a Registered Representative with Securities America, Inc., a Registered Broker/Dealer, member FINRA/SIPC. Advisory services offered through Securities America Advisors, Inc., A SEC Registered Investment Advisory firm. Armstrong Advisory Group and Securities America are not affiliated. He can be reached at 1-800-393-4001 or by e-mail at email@example.com.