Money Matters: Roth 401(k) plan could increase retirement income by 50 percent

By Ashley Wilson The Daily Record Newswire The Roth 401(k) can be an attractive add-on feature to a company retirement plan. Just like its twin, the Roth IRA, the Roth 401(k) allows investors to make retirement contributions with tax-free distributions at retirement. The trade-off for investors is that contributions go into the account on an after-tax basis, so there is no benefit from the tax-deduction up front. Investors with higher incomes for years have experienced frustration because of the eligibility restrictions on Roth IRA contributions. However, eligibility rules are different in a Roth 401(k) plan, so any participant can save as much as $16,500 in 2011 (or up to $22,000 for people older than 50). The IRS allowed 401(k) plans to add this feature beginning in 2006, and their popularity has increased significantly over the last five years. It's no surprise because Roth 401(k) plans have some attractive features: No taxes on qualified distributions Employer-matching contributions can be made on designated Roth contributions No requirement to withdraw money at age 70?, unlike traditional IRA and 401(k) accounts There are several free online calculators that show how the Roth 401(k) and the traditional 401(k) measure up. For example, assume that an investor has 15 years until retirement, annual 401(k) contributions are $16,500, and the account is growing 8 percent annually. The investor's current tax bracket is 35 percent and will remain the same in retirement years. According to one calculator, retirement income from a Roth 401(k) would be 54 percent higher compared to a traditional 401(k). Even if the investor's tax bracket declines to 15 percent in retirement years, income would still be 18 percent higher than a traditional 401(k). There are two main drawbacks to the Roth 401(k) option. First, any contributions made are irrevocable. An election of pre-tax contributions cannot be changed once they have been designated to a Roth. Second, withdrawals could be taxable under certain circumstances. To avoid taxation, an investor must wait until age 59? or five years from when designated Roth contributions were first made to the plan - whichever is longer. For example, let's say an investor retired this year at the age of 65. The investor began contributing to the Roth 401(k) three years ago and would like to draw income out of that account. Taxes would be owed on any earnings on the amount withdrawn. The process of adding a Roth 401(k) option to an existing 401(k) plan is actually fairly simple and painless. All that is required is an amendment to the current plan document. The cost of an amendment is usually about $200. A plan administrator can take care of it. The bottom line for a Roth 401(k) is that you will miss out on the tax break on contributions in your working years, but you won't have the tax bite on withdrawals in your retirement years. ---------- Ashley Wilson is a financial adviser with the Wilson Financial Group of Stifel, Nicolaus & Co. Inc., member SIPC and NYSE, in Portland. Contact her at 503-499-6260 or wilsonam@stifel.com. Neither the author not Stifel, Nicolaus & Co. offer tax advice. Consult with a tax adviser before taking action. Published: Thu, May 12, 2011