The Roth 401k is a retirement savings plan which combines a number of the most-positive features of the traditional 401(k) and the Roth IRA. And the best part is that it puts a beneficial twist on an already awesome retirement savings plan.
Under the Roth 401k, employees can choose to add money to their plans on an after-tax basis, along with, or as opposed to, the before-tax deferrals which are applied to their traditional 401(k) plans. This means the employee has the option of participating in one, or both of these plans, provided they meet the requirements set forth by the rules of each respective plan.
An employee's combined elective deferrals, whether placed in a traditional, Roth 401k, or both, are limited to a maximum of $16,500 for tax year 2011, provided that the account holder is under 50 years of age. If the individual is older than 50, the rules allow them to add an extra $5,500.
Matching contributions made by employers are not factored into the $16,500 cap. These are pretax dollars which are placed in a separate account, allowed to accumulate, and then taxed as ordinary income at withdrawal.
The primary difference between a Roth 401k and a traditional plan concerns when the monies are taxed. A Roth happens to be funded with after-tax dollars. A traditional 401(k) is funded using before-tax dollars.
What exactly does this mean?
After-tax dollars are funds for which you've paid taxes on for the current year. So, if your taxable income for the year was $75,000, you pay the taxes, and then make your contribution to your Roth 401k. Of course, this may drastically lower your take-home pay. However, these contributions, along with any accumulated earnings, can never be taxed again.
Before-tax dollars are those which are not counted in your taxable income for the current year. So, if you earned $75,000 for the year, and elected to contribute the maximum $16,5000 to a traditional 401(k), your taxable income would be reduced to $58,500. But this is only a tax deferral. When you year age 70 1/2 and become subject to mandatory distributions (withdrawals) you will then have to pay any and all applicable taxes.
A Roth 401k account is probably more-advantageous to individuals thinking about starting a Roth IRA. Employees at a younger age who usually find themselves in lower tax brackets, but who expect to be in a high tax bracket when they hit retirement age, would likely benefit from participation in a Roth.
However, if a worker is in their peak earning period, and they anticipate their tax bracket will be lower at retirement, they would most likely benefit from staying in a traditional 401(k) savings plan.
Another consideration which must be made when deciding to invest in a Roth 401k is that contributions are irrevocable. Once contributions have been made, you can't change your mind and transfer them into a traditional 401(k). That being said, however, funds from a Roth 401k can be rolled over to a Roth individual retirement account when an employee leaves their job.
Employers have been slow to offer Roth 401k, as well as, traditional plans in their employee benefits packages. The most common reason given for this reluctance is the fear of added administrative, record-keeping and payroll burdens. However, as more high-profile firms add both these plans to their benefits choices, it has been predicted that smaller business will likely jump on board.
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