The Roth 401(k) - New Kid In Town

Posted by Nick Niesen on November 8th, 2010

A traditional 401k plan is an arrangement under tax law by which an employer can deduct pre-tax money from your paycheck and the employee can invest it. In a traditional 401k this money is nontaxable until you withdraw it, at which time you will likely be in a lower tax bracket.

Those who are looking into retirement savings plans should also take not of the Roth 401k that became effective in 2006. The Roth 401k is a hybrid between the traditional 401k and the Roth IRA, and was legislated in George W. Bush?s tax cut package. It operates differently than the traditional 401k plan. Below is an explanation of the pros and cons of the Roth 401k:
The bad news:
- Favorable tax treatment limited to those who are disabled, or at least 59.5 years old, or who have held the account for more than 5 years

- it is not available to taxpayers with an income above a certain level at the time their account is opened.

- There is no upfront tax deduction

- employees whose employers do not offer Roth 410k plans are ineligible

- Not many employers offer Roth 401k plans because it is new, and because it is expensive to introduce.

The good news:

- Any employee whose employer offers the plan is eligible.

- Withdrawals taken after retirement are no subject to income tax

- It can be rolled over into a Roth IRA if you quit your job.

- There is no loss of eligibility for if your income exceeds maximum eligibility limits after your account is opened.

- Because of the deferred tax benefits, Roth 401k accounts can appreciate faster than a traditional plan, leading to higher retirement income.

This structure makes the Roth 401k suitable for youth who expect their income to grow over time. A traditional 401k plan will leave you more money now, but a Roth 401k will leave you better off after retirement.