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Plan Insight

SEPTEMBER 2010 Newsletter

For Many Savers, Roth 401(k) Accounts are Worth Consideration

Since being rolled out in January 2006 to the cheers of most of the financial planning community, Roth 401(k) accounts have yet to gain much traction with 401(k) savers.

According to a 2009 survey by Vanguard, only 7% of those with access to a Roth 401(k) account use one. I'm convinced that the primary reasons this powerful wealth accumulation tool has been largely ignored are a lack of information and apathy.

So let's review the basics of Roth 401(k) accounts.

Anyone, regardless of age or income, can make after-tax contributions to a Roth 401(k) account if it is available.

Like a traditional 401(k) account, a Roth 401(k) account has a maximum annual payroll deduction contribution in 2010 of $16,500. If you're 50 or older, there's an additional $5,500 "catch-up" contribution allowed that brings the total up to $22,000.

Roth 401(k) contributions also are treated like traditional 401(k) contributions in terms of their eligibility to be matched by the company.

The big difference is that you receive no upfront tax deduction for your contribution to a Roth 401(k) and in exchange are allowed to withdraw all contributions and earnings free from taxation after five years of opening the account and age 59 1/2.

Think about it: a lifetime of tax-free wealth accumulation instead of building a large retirement nest egg that will be subject to the prevailing income tax rate when you decide to withdraw your savings in retirement.

Roth is Not for Everyone

The key question that needs answered is whether the value of the tax break immediately lost is surpassed by the value of the tax break you will receive when you withdraw your earnings income tax-free.

This question is not easily answered because it requires one to predict the future regarding the following three variables:

The length of time you will leave your savings in the account.

The rate of return you will earn.

The difference between your tax bracket when you make contributions compared with your tax bracket when you take withdrawals.

After 3 1/2 years of meeting with 401(k) participants to discuss these difficult questions, we have identified a handful of 401(k) participant "profiles" to help guide your decision (see chart next page).

Theoretically, collecting your tax savings up front allows you to invest more and yields an identical amount of after-tax money at retirement than foregoing the deduction in exchange for tax-free distributions. This assumes your tax bracket does not change and you are able and willing to calculate the net cost difference between the two and invest the difference.

However, the vast majority of retirement savers don't go to the trouble of investing their tax savings into a traditional 401(k) account, so many are likely to be better served funding a Roth 401(k) account.

While many financial planning experts agree with this point of view, not all do. That still doesn't explain the large number of employees who have yet to consider starting a Roth 401(k) account or employers who have yet to amend their 401(k) plans to allow their employees to make this decision for themselves.

If you have not made the Roth 401(k) account available in your plan, and you and your employees fit one of the profiles in the chart (next page), an amendment will add this feature to the plan.


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Information is provided for review and consideration only. Please consult legal and tax advisors for practical advice pertaining to your business and personal situations.

Material in our newsletter may have been extracted in whole or in part from the IRS Employee Plans publication, and the presence of IRS material does not constitute or imply the endorsement, recommendation, or favoring by the IRS of any opinions, products, or services offered by the sponsor of this web page or document.

This page was last reviewed and/or updated on Friday, July 03, 2015 05:21 PM


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