Not all corporate employees realize that Roth 401k deferrals have been allowed since January 1st of 2006. The Roth 401k, like a Roth IRA, allows accounts to grow tax-free and allows for tax-free withdrawal of contributions, earnings, and interest. Funds are eligible for withdrawal at age 59 1/2 assuming you’ve held the account for at least 5 years. The ‘drawback’ is that you can’t take a tax deduction at the time of deferral the way you can with a traditional 401k. Many financial advisors feel that Roth plans, if you qualify for them, are more valuable than traditional plans. Technically, it depends on a few different factors including your current tax bracket, your retirement tax bracket, and which direction marginal tax rates are headed for in the future.
The reason I mention qualifying is that many of my readers don’t realize that you can get ‘phased out’ of making a contribution. For an IRA, the phaseout is $156,000-$166,000 in adjusted gross income if you’re married. It’s $99,000-$114,000 if you’re single. For an IRA, the annual contribution limit is $5,000 in 2008, $6,000 if you’re age 50 & above.
For a Roth 401k the boundaries are non-existent. A taxpayer who is married will not be phased out of making these contributions at any level. The only question you need to ask is whether your 401k plan offers the Roth contribution. If it doesn’t, and you want to make Roth contributions, should speak to your employer or HR department.
The Roth 401k is particularly attractive to higher-earnings individuals, or those that would mostly likely be phased out of IRA contributions. Unlike the $5,000 max in the IRA, an employee could defer the full $15,500 for 2007, or $20,500 if they are over age 50. Do you see what I’m getting at here? The restrictions don’t apply if you’re contributing through the 401k plan. So if you have a Roth IRA but are making 401k deferrals, you may want to re-examine your options.
If an employee is split about whether a Roth IRA is more valuable than taking the tax deduction now, they can split contributions between the regular and Roth 401k plans. It really is the best of both worlds.
Money held in Roth accounts also avoids the Required Minimum Distribution (RMD) rules. In non-Roth 401k and IRA plans, you must begin taking distributions when you pass age 70 1/2. While that may seem insignificant to a 40 year-old now, you will complain about the taxes when you eventually get older–I promise RMD is really the government’s way of saying “hope you’ve enjoyed your tax shelter–now start paying!” Roth money is not subject to RMD and thus continues the theme of tax-free growth forever! Avoiding RMD obviously helps beneficiaries as well, who may have a greater chance at getting the full value of your IRA if it’s in a Roth-ruled account.
Just some food for thought.
Premier Financial Advisors
14 E. 60th St. #402
New York, NY 10022
Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.