Roth 401k Plan

  Life is unpredictable and calamity in any form might strike you at any time. So, you need to be financially prepared for the future, in order to avoid unnecessary tension or problems. The day you start earning money, you need to think of some good savings plans. If you are an employed individual, then the new savings option- Roth 401k plan should be the ideal choice.

Roth 401k – Basic Facts

Along with traditional 401k plan, many employers offer a Roth 401k. Characteristically, it is just the opposite of traditional 401k. In this employer sponsored investment plan, you need to pay taxes on your contributions, but not on your withdrawals. You can withdraw the money once you reach the age of fifty-nine and half years. This plan is specifically beneficially to those, who belong to the high income group. Earlier, with traditional Roth IRA there were some income restrictions. However, Roth 401k, with effect from the year 2006, has proven to be much beneficial to the higher earning groups. In the year 2010, a single filer earning between $105,000 and $120,000 was eligible for this plan. If you want to file jointly with your spouse, this limit becomes $167,000 to $177,000. As you are not paying taxes on withdrawals, your fund grows tax free and further at the time of withdrawal, you don’t have to pay any income tax as well.

Another beneficial feature of this plan is, unlike a traditional 401k, you do not have to make any required minimum withdrawal as soon as you reach the age of seventy and half years. Even after you reach the age of retirement, you can leave your money untouched for decades and let it grow more. This “no-RMD” feature helps an individual a lot in estate planning.

If your organization offers both traditional and Roth 401k, you can apply for both and divide your savings into the two accounts. Though both the accounts have same investment options, in order to be eligible, your annual income should not exceed $16,500, for the year 2010. However, if you are 50 years or more, the limit is $22,000.

This investment plan is particularly beneficial for those high earning individuals, who might be in higher tax brackets at the time of their retirement, than they are at present. The traditional 401k is generally funded with pretax money, which in turn increases the amount invested in the savings account. However, you need to pay tax on every withdrawal. On the other hand, Roth 401k, which is an “after tax program”, has no restriction involving high income group people, unlike IRA Roth401k.

Eligibility Criteria for Roth 401k Plan

Though Roth 401k has been outlined after Roth IRA, the contributions toward this fund is made from earnings after tax payment. Regardless of what income bracket you are in, Roth 401k can be chosen by you.

If you are a married person and filing jointly with your spouse, and your Adjusted Gross Income (AGI) is less than $169,000 in the year 2011, you can make contributions to this plan. However, if you are filing tax as a single individual, with AGI less than $107,000 for the year 2011, then despite your involvement in a qualified retirement plan you can opt for Roth 401k.

There is no income limitation for an individual contributing to a Roth 401k plan. You are eligible for this plan, if as a single your AGI is between $105,000 and $120,000 and as a married and joint filer; it is between $167,000 and $177,000. If you want to opt for both traditional and Roth 401k plans, then you need to make sure that your total contribution does not exceed the maximum specified amount.

With a Roth 401k, you need to consider annual distributions once you reach the age of seventy and half years. You can even roll over funds from this plan to Roth IRA, which would not require any distribution. You can switch from regular IRA to Roth IRA, if you are ready to pay taxes on the amount that would have been taxable, if withdrawn. However, if you have a regular 401k, there is no provision for converting into Roth 401k.

Benefits of Roth 401k

Some of the advantages of Roth 401(k) plan are as follows:

  • As an employee, you are immediately 100% vested with your own tax overdue contributions. In case, you decide to leave the employer, you can roll your account into a new Roth 401(k).

  • As an individual, you can defer up to $16,500 for the year 2009. If you are over 50 years, you can contribute an additional amount of $5,500 in 2009. However, the limit gets reduced if contribution is made to a regular 403(b) or a 401(k). Suppose, you are below 50 years and if for a financial year you contribute $10,000 toward a regular 401k plan, then you can put only $5,500 toward a Roth 401k during that year.

  • As Roth 401k is funded by after-tax money, you can withdraw your contributions whenever you want, without having to pay for any penalty or taxes. However, till you reach the age of fifty-nine and half years, you cannot withdraw an amount that is beyond your contribution and provided the account is for 5 years (except under some special conditions). If before attaining the specified age, you decide to withdraw an amount beyond the contribution, then you need to pay a penalty of 10 % along with income taxes.

  • If you are in a higher tax bracket at the time of retirement than you were when you have contributed money toward Roth 401k, then with this plan you will be allowed to pay a lower tax rate, than you would in a regular 401k. This is because; during the time of retirement the withdrawal amount is tax free.

  • Some Roth 401k plans offer “equal contribution” from the employer. This means, your contributed amount will be matched by your employer and put into your retirement fund. Suppose you are earning $50,000 and contributing $4000 toward your Roth 401k account, your employer will also contribute 5% of your annual salary, i.e. $2500 toward the fund. However, this matched contribution is more found in case of a regular 401k.