The Roth 401K, as the name suggests, is a hybrid offering: a combination of the Roth IRA and the traditional 401K plans. US employers will have the opportunity to start offering this plan to employees beginning 2006. A Roth IRA is an individual retirement account (IRA) in the United States. ... The 401(k) plan is a type of retirement plan available in the United States. ...
In a traditional 401K plan, employees contribute money before tax to the 401K plan. For example, an employee earning $60,000 per year and contributing the maximum permissible $14,000 in 2005 to a 401K would pay federal and state income taxes only on $46,000. The money invested in the 401K plan will grow and will be taxed as regular income when taken out at age 59.5 years or older.
In case of the Roth 401K, the employee can now decide to make post tax contributions rather than pre tax in the normal 401K, the advantage being that distributions from the Roth 401K at age 59.5 or older will be completely tax-free.
This is similar to the Roth IRA (which generally allows a maximum post-tax contribution of $4000 per year as of 2005), in that they money may be withdrawn completely tax-free after age 59.5.
The Roth 401K contribution limit will be $15,000 in 2006. Note that the limit applies to the combimed contributions to the regular 401K and the Roth 401K; for example, a person could not contribute $15,000 to a Roth 401K and $15,000 to a regular 401K in the same year. However, contributions may be split between both types of 401K's as long as the total does not exceed the limits in the given year.
There are some caveats however:
If employers provide a matching contribution, it will be pretax money and will go only into the regular 401K account.
Contributions are irrevocable. Once the money goes into a Roth 401K account, it can't be switched over to a regular 401K.
Employees can roll over their Roth 401K contributions to a Roth IRA when they retire or if terminated.
It is up to the employers to provide the Roth 401K in addition to the regular 401K and many may decide not to do so because of the added administrative burden.
The Roth IRA effectively reverses the order of the 401k and allows for post-tax contributions, but tax free growth and qualified distributions, if the contributions have been invested for at least 5 years.
The basic difference between a Roth401(k) and a traditional 401(k) is that the Roth version is funded with after-tax dollars while the traditional 401(k) is funded with pre-tax dollars.
Additionally, normal Roth IRA contributions are limited to $4,000; whereas, up to $15,000 could be contributed to a Roth401k account, provided no other elective deferrals were taken for the tax year (no traditional 401k deferrals taken).
A 401(k) lets you defer paying taxes on your savings until you withdraw the money in retirement, when your income tax rate is likely to be lower.
If that same person were to choose a Roth401(k) instead, the 25% tax would be levied on the full $50,000 and the tax would be $12,500, an increase of $1,250.
But that same $15,000 contributed to a Roth401(k) would leave her with a bill of $25,200, a difference of $4,200.
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