Roth 401(k)s - Arriving Soon at a Retirement Plan Near You?
By Sylvia Bell, JD, Senior Manager of Retirement Benefits, Alpern Rosenthal
Beginning in January 2006, employers sponsoring 401(k) plans may offer
plan participants an alternative to traditional pre-tax contributions
– a Roth contribution in the qualified 401(k) plan. A Roth contribution
in a 401(k) plan is salary contributed to the Plan on an after-tax basis
which, when distributed to the employee, comes out of the plan without
being taxed. Unlike Roth IRAs, there is no salary limitation to participate
in the Roth account.
Roth IRAs have been popular since their introduction in 1998 because
the earnings on funds invested in such accounts build up tax free (as
opposed to merely tax deferred in a traditional IRA). However, a significant
portion of the investing population has been shut out of the Roth IRA
market either because their income is above the Roth IRA contribution
limit (which generally ranges from $110,000 to $160,000, depending on
their filing status) or because they don’t have any funds available
to make Roth IRA contributions after funding their 401(k) contribution.
There are two significant economic factors that should be considered
when choosing a Roth contribution. First, Roth contributions may be
preferable for employees who anticipate higher tax rates in the future
(when they want to withdraw their retirement savings). Second, Roth
contributions may be exceptionally appealing to those employees who
have continually high savings rates and are nearing the tax code’s
contribution limits.
Generally, under current qualified retirement plans, money contributed
into retirement accounts is done on a pre-tax basis and taxed on distribution.
Alternatively, money contributed into a Roth account in a 401(k) plan
is subject to federal income tax at the time of contribution, but neither
the contributions nor the earnings on that contribution are subject
to income tax on distribution at retirement.
Roth contributions may appeal to those who anticipate that:
? Federal tax rates may increase in the future
? They may take a hardship withdrawal (10% penalty tax would not apply
to the basis of a Roth distribution)
? They would like to maximize their contributions.
Roth contributions also have the potential for estate planning advantages.
Traditional pension plan or IRA distributions are required to begin
in the April following the year the participant attains age 70 ½.
These distributions are known as Required Minimum Distributions (RMD).
RMDs are not required for Roth IRAs. By rolling a distribution from
the Roth account into a Roth IRA the individual is not required to take
a distribution. Therefore, the account can continue to “build”
without being depleted for required minimum distributions and can be
a part of a planned estate transfer. The Roth IRA may offer an excellent
opportunity to transfer funds at death without the required periodic
distribution and normal tax issues that an inherited IRA poses. The
IRS has not issued any guidance related to this issue, but currently
Roth IRAs are not subject to RMDs.
For employers, offering Roth contributions, the greatest challenge
is to prepare employees for the choice between traditional and Roth
contributions. The tax question is complex and the employee’s
belief about his/her current tax rate and his/her estimate of future
rates and future income level is critical to this decision. Implementing
a Roth account would entail carefully drafted rollout communications
as well as ongoing communications; changes to payroll, recordkeeping;
and coordination of rollovers, testing and catch up contributions.
The next step for employers who are considering offering Roth contributions
is to:
? Determine the level of interest among employees, especially those
not participating and employees that are key to the organization
? Determine when record keeper and payroll systems can be ready to accommodate
Roth contributions
? Evaluate advantages of Roth contributions against plan objectives
to determine if advantages outweigh the additional administrative burdens
? Arrange for excellent communication to assist employees in understanding
the advantages and disadvantages of Roth accounts.
For more information, contact Sylvia Bell, JD, Senior Manager of
Retirement Benefits for Alpern Rosenthal, at 412.281.2501, ext. 335
or at sbell@alpern.com.
Back
|