It has been six years now since the doors opened for 401(k) plans to allow ROTH contributions. Most employers by now have amended their plans to allow these contributions but few employees understand the rules or even know it exists. Here’s the scoop:
- ROTH means taxable contributions with tax-free return. If you change some or all your deferral from regular 401(k) to ROTH 401(k) then the contribution becomes taxable. However; all of your gains are tax free, never to be taxed by you or your heirs (still subject to penalty prior to age 59½).
- ROTH means no Required Minimum Distributions at 70½. Regular IRA and 401(k) accounts are required to distribute a minimum amount at age 70½ that increases each year thereafter. ROTH money has no distribution requirements so it can be saved to the end of your life for long term care, end-stage costs, or to be passed to your heirs.
- ROTH 401(k) means no income limits. This is confusing: You cannot make contributions to a ROTH IRA if your income is above certain limits. ROTH IRA income limits do not apply to ROTH 401(k) contributions. Anyone, regardless of their income, can elect ROTH 401(k) contributions.
- Company match and profit-sharing is never ROTH money. Any money you receive from your employer will always be tax-deferred regular 401(k) money. Only your elected deferral amount can be shifted over to ROTH 401(k).
If your tax rate is not too bad right now and your tax-deferred IRA’s and 401(k)’s are doing nicely, you should consider changing some or all of your 401(k) contribution over to ROTH 401(k). Tax rates could trend up to pay for the national debt our country has accrued. Also, your personal tax bracket could increase as you lose deductions for kids as they grow up and mortgages as they get paid off. ROTH 401(k) contributions are a great way to take advantage of low tax rates.
This is just the tip of the iceberg when it comes to ROTH 401(k) planning and considerations so consult with your adviser prior to making any changes. Any questions or comments are always welcome.
By Rob Schulz