It may be time to give an “innovative” type of retirement plan a second look.
Strategy: Consider a Roth 401(k) plan for your company. As the name implies, this setup combines elements of 401(k) plans and Roth IRAs.
Why are Roth 401(k)s back in the public eye? Uncle Sam just announced they’re approved for millions of federal government workers. Private employers may be intrigued.
Here’s the whole story: The Roth 401(k) concept was created in 2001 by the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), but it wasn’t available until 2006. As with your regular 401(k) plan, contributions to a Roth 401(k) plan grow on a tax-deferred basis. However, unlike a regular 401(k), elective deferrals aren’t made with pretax dollars. The amounts you contribute are subject to current tax.
With a Roth 401(k) plan, you come out ahead on the back end: If you qualify, distributions from the plan are 100% federal income tax-free. In comparison, the distributions from a regular 401(k) plan are taxable at ordinary income rates.
To qualify for the tax-free deal, distributions from a Roth 401(k) must be made after you reach age 59½ or on account of death or disability.
In other words, the rules for qualified (tax-free) distributions from a Roth 401(k) mirror the tax rules for qualified Roth IRA distributions.
The contribution limits for traditional 401(k) plans and Roth 401(k) plans are the same. So, you can contribute up to $17,000 to either type of account for 2012 ($22,500 if age 50 or older). Alternatively, you can divide your contribution between the two types of plans, when it is allowed by the plan administrator.
The availability of contributing to Roth IRAs phases out for certain high-income taxpayers, but there is no income restriction on Roth 401(k) contributions. So this may represent a new opportunity to cash in on Roth-type benefits.
Tip: For employers, Roth 401(k)s create extra administrative burdens. Weigh the benefits for employees against the hassle.
Online resource: For more information on Roth 401(k)s, see Retirement Plans FAQs on Designated Roth Accounts.