The NEW ROTH 401(k) Plan – Effective 1/1/2006
By Paul M. League, QFP, CFP® · www.LeagueFinancial.com
The ROTH 401(k) sounds a lot like a
defined contribution 401(k) Plan that allows one to defer part of their salary
into a tax-deductible and tax-deferred (retirement) savings account, but with
the new ROTH 401(k) the tax-deduction is forfeited in return for the ability of
participants to receive tax-free distributions after five years.
This new retirement plan, authorized by
the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), became
available to participants as of January 1, 2006.
The IRS recently issued initial guidance
through new proposed regulations as follows:
As with a regular 401(k) plan, an employee
can elect to defer salary to the ROTH 401(k), but in this case the contributions
are made on an after-tax basis. There is no current tax on any
accumulations within the ROTH 401(k) plan. As with a ROTH IRA, qualified
distributions from a ROTH 401(k) Plan are completely tax-free after five years
if they are paid:
- For
a qualifying first-time home purchase;
- At
or after the death of the contributor; or
- On
account of disability; and,
-
After the recipient reaches age 59 ½.
Distributions from ROTH 401(k) accounts
intended for rollover are only permitted to be rolled over into other ROTH type
accounts (i.e. either another ROTH 401(k) plan or a ROTH IRA).
The new
regulations establish 3 (three) requirements for ROTH 401(k) plans:
-
Employee contributions are to be treated by the employer as taxable
compensation (as if the employee had received cash instead).
- The
employee must make an irrevocable designation of a ROTH contribution at the
time of the deferral.
- ROTH
contributions must be maintained in a Separate Account (separate accounting
applies to the contributions and earnings thereon until all ROTH contributions
have first been distributed).
Most of the typical requirements and rules
for qualified plans also apply to ROTH 401(k)s; however, unlike the ROTH IRA,
the above contribution method is available for all plan participants,
regardless of the amount of their income.
Additionally, in-life or “lifetime
distributions” from a ROTH 401(k) plan are mandatory.
Is a ROTH 401(k) plan best for you?
As with most financial decisions this
depends on your plans for retirement and the other resources currently or later
available to you to meet your retirement needs. We recommend the assistance of
a professional with respect to all of your retirement-planning needs.
