Roth vs 401k
The Roth IRA, first established in 1998, allowed employees, including self-employed individuals, to deposit post-tax funds into their Roth IRA investment accounts. The advantage to the individual was the ability to secure tax-free growth of the invested funds as well as tax-free distributions at retirement.
For those individuals who knew for certain, or individuals who believed there was a substantial likelihood, that they would be in a higher tax bracket upon retirement, the Roth IRA offered an appropriate method of insuring the benefit of tax-free investment earnings growth as well as tax-free distributions at retirement. However, the allowable annual contribution amounts to the Roth IRA were substantially less than those amounts allowable under a traditional 401k plan, thus limiting the Roth IRA's appeal.
Roth 401k
The Roth 401 k combines the most advantageous aspects of both the Roth IRA and 401k plans, namely, the after-tax funding mechanism of the Roth IRA, in conjunction with the more generous contribution allowances available under 401k retirement plans.
In short, the difference between a traditional 401k and a Roth 401k, is that contributions pursuant to a Roth 401k are funded with post-tax dollars.
Employees can now elect to have contributions to their Individual 401k plans made on a Roth 401k basis.
The permissible Roth 401 k maximum contribution amounts for 2009 are $16,500 ($22,500 if over 50). Withdrawals can be taken from the Roth 401k at age 59 1/2, as long as the employee has had a Roth 401k established for at least 5 years. Upon retirement, the distributions from the Roth 401k are tax-free.
For whom might a Roth 401k be appropriate?
If you are a relatively young employee, and likely to move into a higher tax bracket later on as you approach retirement, contributions made on a Roth 401k basis would make sense. Regardless of age, if you have made substantial contributions to your 401k account during your working years such that your withdrawals upon retirement may push you into a higher tax bracket, a Roth 401k may be a suitable choice a well.
Finally, if you are nearing retirement and feel that federal tax rates are destined to increase in the future, contributions made on a Roth 401k basis would help limit your potential increased tax exposure when you start making withdrawals upon retirement.
There are some important caveats regarding the Roth 401k. Employer matching contributions to a designated Roth 401k cannot be made into the designated Roth account and must be made on a pre-tax basis. For Individual 401k plans, the profit sharing portion of the annual contribution cannot be made on a Roth 401k basis; it must be made with pre-tax dollars.
Roth 401k contributions are irrevocable. That is, once money is invested in a Roth 401k, it cannot be moved later to a regular 401k or Individual 401k account.
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