Roth 401(k)

Roth 401(k): An Introduction to the After-Tax Roth 401(k) Contribution Option
In addition to traditional before-tax 401(k) contributions, your plan may also permit eligible plan participants to make after-tax contributions to a “Roth” account. Participants in plans offering the Roth 401(k) feature can designate all or part of their contributions as after-tax contributions to a separate Roth 401(k) account. Please check with your Plan Administrator to determine if this feature is available in your plan.

Before-tax and after-tax contributions are kept in the same 401(k) plan, but in separate accounts for tax purposes. The account statement will show the before-tax 401(k) balances and the after-tax Roth 401(k) balances separately. Because Roth 401(k) contributions are made after-tax, these contributions are always 100% vested.

Eligibility and Contribution Limit
Unlike a Roth IRA, eligible participants may make Roth 401(k) contributions, regardless of their income level. In 2009, the individual 401(k) limit of $16,500 (plus an additional $5,500 “catch-up” contribution, if participants are age 50 or older) applies to the combination of traditional before-tax 401(k) and Roth after-tax 401(k) contributions, not to exceed the plan’s limit.

Making the Decision: Contribute Before Taxes, After Taxes or Both?
No matter which option you choose, it’s important to plan and save for retirement.
In making the decision about whether to contribute before-tax, after-tax, or both, you’ll need to consider the answers to the following questions:

• What is your income tax rate today?
• What do you expect your income tax rate will be when you retire?

Why contribute before taxes?

• If you think you’ll pay a lower tax rate when you retire than what you’re paying now, you may be better off contributing to your 401(k) on a before-tax basis, in order to reduce the income taxes you pay today. You’ll pay income on your 401(k) distributions in retirement, but at a presumably lower rate.

Why contribute after taxes?

• If you think you’ll pay higher taxes when you retire than you’re paying now, after-tax Roth 401(k) contributions make sense. You’ll be paying taxes on your contributions today, but not on your future qualified retirement distributions.
• If you would like to delay taking distributions from your 401(k) until after you reach age 70 ½ ¹, consider making after-tax Roth 401(k) contributions. Prior to reaching your plan’s required minimum distribution date, your after-tax Roth 401(k) money may be rolled into a Roth IRA , allowing you to skip taking the required minimum distribution from your 401(k) at age 70 ½.

Why make contributions both before taxes and after taxes?

• How difficult is it for you to predict whether your income tax rate will be higher or lower in retirement than it is today? If you’re feeling uncertain, you may want to consider contributing to your 401(k) on both a before-tax and an after-tax basis. By investing both before-tax and after-tax, some of your retirement distributions will be taxed as income, some won’t. You’re diversifying your future income tax risk by choosing both options.

If I start making Roth 401(k) contributions at the beginning of the year and later change my mind and want them treated as before-tax 401(k) contributions, can they be re-characterized and transferred from the Roth 401(k) account to the traditional before-tax 401(k) account?

• No, the election to make designated Roth contributions is irrevocable. Once they are designated as Roth 401(k) contributions, they cannot later be changed to before-tax 401(k) contributions.

Need help?
This calculator will help you to compare after-tax Roth 401(k) contributions to those made to a traditional before-tax 401(k).

Qualified Roth 401(k) Distributions
The tax rules for distributions from Roth 401(k) accounts differ significantly from those for traditional 401(k) accounts. If a distribution is a qualified Roth 401(k) distribution, the entire distribution, including any earnings, is free from federal tax.

Qualified Roth 401(k) distributions must satisfy two rules (both, not either/or): the “five-year rule” and the “purpose rule”.

The “five-year rule” is satisfied if the distribution from the Roth 401(k) account is made at the end of the 5-year-taxable period following the participant’s first Roth 401(k) contribution.

For purposes of the “five-year rule”, the participant’s first Roth 401(k) contribution is considered contributed on January 1, even if made on December 31, of that same calendar year. If the participant changes employers, a new five-year period starts with the date of the first Roth 401(k) contribution to the new employer’s plan. However, if the Roth 401(k) account from the previous employer’s plan is rolled over to the new employer’s plan, the previous five-year period is kept.

The “purpose rule” is satisfied if the distribution from the Roth 401(k) account is attributable to the participant’s attainment of age 59½, disability, or death.

Does "One Size" fit all?
There is no “one size fits all” answer for participants considering the Roth 401(k) feature. You may also want to consult with your financial advisor, attorney, accountant or tax professional in helping you decide what approach is right for you. Your decision to contribute before-tax or after-tax dollars to your 401(k) retirement plan should be based on your individual circumstances.