Roth 401(k)s add new retirement savings alternative


Published: Thursday, January 12, 2006 at 6:01 a.m.
Last Modified: Thursday, January 12, 2006 at 12:00 a.m.
NEW YORK - Many American workers will find something new among the offerings in their company-sponsored retirement savings plans this year - a Roth 401(k) account.
The Roth 401(k) is a cross between traditional 401(k) accounts and Roth Individual Retirement Accounts, or Roth IRAs. For some savers, the new accounts will be a good choice because the money they invest won't be taxed in retirement.
"The Roth 401(k) is a fantastic opportunity to sock away a lot of money . . . that grows tax free for life," said Ed Slott, a Rockville Centre, N.Y., accountant who specializes in retirement issues. "If it's offered, I'd definitely contribute."
A survey released this week by Hewitt Associates, a global human resources services firm, found that about 34 percent of the nation's largest employers plan to add Roth 401(k)s to their retirement plan lineups this year.
Savers will want to know how they work before signing up.
The major difference between the new accounts and the traditional 401(k)s has to do with taxes.
Contributions to traditional 401(k)s are made from pretax earnings, meaning that they reduce a worker's taxable income dollar for dollar. But while the savings grow tax-deferred, the money is taxable when it's withdrawn in retirement. With the Roth 401(k)s, contributions are in after-tax dollars. The savings grow tax-deferred, but the money can be withdrawn in retirement tax free.
That makes the new 401(k)s more similar to Roth IRAs, which were named for the late Delaware senator, William V. Roth Jr. Unlike traditional IRAs, which generally are funded with pretax money, Roth IRAs are funded with after-tax dollars and withdrawals are tax free after minimum holding periods.
When it comes to the 401(k)s, contribution limits are the same for the traditional and the Roth accounts - $15,000 for most workers, with an additional $5,000 allowed for those 50 and older. Companies can provide matching funds to either account.
Stephen Utkus, a principal with the Vanguard Center for Retirement Research in Valley Forge, Pa., noted that workers long have been advised to diversify their holdings to include stocks, bonds and other investments. The new Roth 401(k) will allow them to diversify their tax exposure, he said.
"If you're sure you're going to be in a lower tax bracket in retirement, you want to keep contributing to the traditional 401(k); if you think you'll be in a higher tax bracket, you'll want a Roth," he said. "But none of us is sure."
His advice: "Those of you who have been loading up on pretax savings (traditional accounts) will want to diversify to the Roth. You can hedge your bets by having both."
Chris Bowman, vice president for retirement and investor services with Principal Financial Group Inc. in Des Moines, Iowa, said that besides tax diversification, there are other reasons some workers should choose Roth 401(k)s. They include:
  • People who anticipate a meteoric career path, perhaps starting in a low paying job but expecting to make it to the vice president's office someday, with a big retirement package.
  • Young people who are seriously planning and saving now so they'll have significant income in retirement.
    Unfortunately, Bowman said, "the majority of people in this country aren't saving adequately for retirement." As a result, "for most workers, the traditional 401(k) is probably best because they won't have so much income and tax burden in retirement."
    Another consideration for workers who already are good savers is whether to fund a Roth 401(k) or a Roth IRA.
    Slott, the IRA expert, points out that many high-income workers can't contribute to Roth IRAs because their incomes exceed tax code limits of $160,000 for married couples filing jointly and $110,000 for single filers. There are no income limits for the Roth 401(k)s.
    And traditional and Roth IRAs have contribution limits of just $4,000 this year, with an additional $1,000 "catch-up" allowed for workers 50 and older.
    "So a working couple can contribute a lot more with a Roth 401(k)," Slott said. "Each spouse can put $15,000 into a Roth 401(k). It's an opportunity to put a lot of money away that you'll never again have to share with the government."
    --- On the Net: Slott's site: www.irahelp.com www.vanguard.com www.principal.com
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