The Roth 401(k) is a type of retirement Retirement is the point where a person stops employment completely . A person may also semi-retire by reducing work hours. Many people choose to retire when they are eligible for private or public pension benefits, although some are forced to retire when physical conditions don't allow the person to work any more (by illness or accident). In most savings Saving is income not spent, or deferred consumption. Methods of saving include putting money aside in a bank or pension plan. Saving also includes reducing expenditures, such as recurring costs. In terms of personal finance, saving specifies low-risk preservation of money, as in a deposit account, versus investment, wherein risk is higher plan. It was authorized by the United States Congress The United States Congress is the bicameral legislature of the federal government of the United States of America, consisting of the Senate and the House of Representatives. The Congress meets in the United States Capitol in Washington, D.C under the Internal Revenue Code The Internal Revenue Code is the main body of domestic statutory tax law of the United States organized topically, including laws covering the income tax (see Income tax in the United States), payroll taxes, gift taxes, estate taxes and statutory excise taxes. The Internal Revenue Code is published as Title 26 of the United States Code (USC), and, section 402A,[1] and represents a unique combination of features of the Roth IRA A Roth IRA is an Individual Retirement Account allowed under the tax law of the United States. Named for its chief legislative sponsor, the late Senator William Roth of Delaware, a Roth IRA differs in several significant ways from other IRAs and a traditional 401(k) In the United States, a 401 retirement savings plan allows a worker to save for retirement and have the savings invested while deferring current income taxes on the saved money and earnings until withdrawal. This type of plan is also known as a "traditional" 401(k) plan. As of January 1, 2006 U.S. employers have been free to amend their 401(k) plan document to allow employees to elect Roth IRA type tax treatment for a portion or all of their retirement plan contributions. The same change in law allowed Roth IRA type contributions to 403(b) A 403 plan is a tax-advantaged retirement savings plan available for public education organizations, some non-profit employers (only US Tax Code 501(c)(3) organizations),Cooperative hospital service organizations and self-employed ministers in the United States. It has tax treatment similar to a 401(k) plan, especially after the Economic Growth retirement plans In general, a pension is an arrangement to provide people with an income when they are no longer earning a regular income from employment. It is a tax deferred savings vehicle that allows for the tax-free accumulation of a fund for later use as a retirement income. Pensions should not be confused with severance packages; the former is paid in. The Roth retirement plan provision was enacted as a provision of the Economic Growth and Tax Relief Reconciliation Act of 2001 The Economic Growth and Tax Relief Reconciliation Act of 2001 , was a sweeping piece of tax legislation in the United States. It is commonly known by its abbreviation EGTRRA, often pronounced "egg-tra" or "egg-terra", and sometimes also known simply as the 2001 act (especially where the context of a discussion is clearly about (EGTRRA 2001).
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Traditional 401(k) and Roth IRA plans
In a traditional 401(k) In the United States, a 401 retirement savings plan allows a worker to save for retirement and have the savings invested while deferring current income taxes on the saved money and earnings until withdrawal. This type of plan is also known as a "traditional" 401(k) plan, introduced by Congress in 1978, employees contribute pre-tax earnings to their retirement plan, also called "elective deferrals Deferred, in accrual accounting, is any account where the asset or liability is not realized until a future date , e.g. annuities, charges, taxes, income, etc. The deferred item may be carried, dependent on type of deferral, as either an asset or liability. See also accrual". That is, an employee's elective deferral funds (for tax-year 2009 up to $16,500 per tax year for those under age 50 and $22,000 for those over) are set aside by the employer in a special account where the funds are allowed to be invested Investment is the commitment of money or capital to purchase financial instruments or other assets in order to gain profitable returns in form of interest, income, or appreciation of the value of the instrument. It is related to saving or deferring consumption. Investment is involved in many areas of the economy, such as business management and in various options made available in the plan.
Employers may also add funds to the account by contributing matching funds on a fractional A fraction is a number that can represent part of a whole formula In mathematics, a formula is an entity constructed using the symbols and formation rules of a given logical language basis (e.g., matching funds might be added at the rate of 50% of employees' elective deferrals), or on a set percentage basis. Funds within the 401(k) account grow on a tax deferred basis. When the account owner reaches the age of 59-and-a-half, they may begin to receive "qualified distributions" from the funds in the account; these distributions are then taxed at ordinary income Under the United States Internal Revenue Code, the type of income is defined by its character. Ordinary income is usually characterized as income other than capital gain. Ordinary income can consist of income from wages, salaries, tips, commissions, bonuses, and other types of compensation from employment, interest, dividends, or net income from a tax rates. Exceptions exist to allow distribution of funds before 59 and a half, such as Substantially equal periodic payments Substantially equal periodic payments are one of the exceptions in the United States IRS Code that allows receiving payments without the 10% early distribution penalty from a retirement plan or deferred annuity before the usual 59 1/2 age restriction under certain circumstances. The rules for SEPPs are set out in IRS code section 72(t) (for, disability, and separation from service after the age of 55, as outlined under IRS Code section 72(t).
Under a Roth IRA, first enacted in 1998, individuals, whether employees or self-employed, voluntarily contribute post-tax funds to an individual retirement arrangement(IRA). In contrast to the 401k plan, the Roth plan requires post-tax contributions, but allows for tax free growth and distribution, provided the contributions have been invested for at least 5 years and the account owner has reached age 59 and a half. The amounts of income that can be invested in a Roth IRA are significantly more limited than those to a 401(k) are. For 2008, individuals are limited to contributing no more than $5,000 to a Roth IRA, if under age 50, and $6,000, if age 50 or older. Additionally, Roth IRA contributions are prohibited when taxpayers earn a Modified Adjusted Gross Income of more than $110,000, ($160,000 for married filing jointly). Here is a 401(k) versus IRA matrix This is a comparison between 401, Roth 401(k), and Traditional Individual Retirement Account and Roth Individual Retirement Account accounts that compares various types of IRAs with various types of 401(k)s.
The Roth 401(k) plan
The Roth 401(k) combines some of the most advantageous aspects of both the 401(k) and the Roth IRA. Under the Roth 401(k), employees can decide to contribute funds on a post-tax elective deferral basis, in addition to, or instead of, pre-tax elective deferrals under their traditional 401(k) plans. An employee's combined elective deferrals-- whether to a traditional 401(k), a Roth 401(k), or to both-- cannot exceed $16,500 for tax year 2009 if a participant is under 50; if they are over 50, they may contribute an additional $5,500. Employer's matching funds are not included in the $16,500 elective deferral cap, but are considered for the maximum section 415 limit, which is $49,000 for 2009. Employers are permitted to match contributions to a designated Roth account, but the matching funds must be made on a pre-tax basis, not be made into the designated Roth account, and cannot receive the Roth tax treatment. (Pub 4530)
In general, the difference between a Roth 401(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. After-tax dollars represent money for which taxes are paid in the current year, and pre tax dollars are those that do not represent federal taxable income in the current year. Typically, the earnings on Roth contributions will be tax free as long as the distribution is made at least 5 years after the first Roth contribution and the attainment of age 59 and one half, unless an exception applies.
A Roth 401(k) plan will probably be most advantageous to those who might otherwise choose a Roth IRA, for example, younger workers who are currently taxed in a lower tax bracket Tax brackets are the divisions at which tax rates change in a progressive tax system . Essentially, they are the cutoff values for taxable income — income past a certain point will be taxed at a higher rate, but expect to be taxed in a higher bracket upon reaching retirement age. Another consideration for those currently in higher tax brackets is the future of income tax rates in the U.S. (if income tax rates increase, current taxation would be desirable for a wider group). The Roth 401(k) offers the advantage of tax free distribution, but is not constrained by the same income limitations. For example, normal Roth IRA contributions are limited to $5,000 ($6000 if age 50 or order); whereas, up to $16,500 could be contributed to a Roth 401(k) account, provided no other elective deferrals were taken for the tax year (no traditional 401(k) deferrals taken).
Adoption of Roth 401(k) plans has been relatively slow, and stated reasons for this include the fact that they require additional administrative recordkeeping and payroll processing.[2] However some larger firms have now adopted Roth 401(k) plans, and this is expected to spur their adoption by other firms including smaller ones.[3]
Additional considerations
- Roth 401(k) contributions are irrevocable, such that once money is invested into a Roth 401(k) account; it cannot be moved to a regular 401(k) account.
- Employees are able to roll their Roth 401(k) contributions over to a Roth IRA account upon termination of employment Termination of employment is the end of an employee's duration with an employer. Depending on the case, the decision may be made by the employee, the employer, or mutually agreed upon by both.
- It is the employer's decision as to whether the company will provide access to the Roth 401(k) in addition to the traditional 401(k). Many employers may feel that the added administrative In business, administration consists of the performance or management of business operations and thus the making or implementing of major decisions. Administration can be defined as the universal process of organizing people and resources efficiently so as to direct activities toward common goals and objectives burden outweighs the benefits of the Roth 401(k)
- The Roth 401(k) plan will now be available after December 31, 2010 since the Pension Protection Act of 2006 The Pension Protection Act of 2006 , 120 Stat. 780, was signed into law by U.S. President George W. Bush on August 17, 2006 was passed to extend the program. The program was originally set up to sunset In public policy, a sunset provision or sunset clause is a provision in a statute or regulation that terminates or repeals all or portions of the law after a specific date, unless further legislative action is taken to extend it. Most laws do not have sunset clauses; in such cases, the law goes on indefinitely, or no longer be in place, after 2010 along with the rest of EGTRRA 2001.
- Unlike Roth IRAs, owners of Roth 401(k) accounts (designated Roth accounts) must begin distributions upon reaching age 70 and a half, similar to required minimum distributions for IRA and other retirement plans. (Pub 4530)
See also
- 401(k) IRA matrix This is a comparison between 401, Roth 401(k), and Traditional Individual Retirement Account and Roth Individual Retirement Account accounts - 401k & IRA comparisons (401k vs Roth 401k vs Traditional IRA vs Roth IRA)
References
- Understanding the Roth 401k Retirement Plan
- Designated Roth Accounts in 401(k) or 403(b) Plans, Information from the IRS website.
- IRS Publication 4530 (pdf Portable Document Format is an open standard for document exchange. The file format created by Adobe Systems in 1993 is used for representing two-dimensional documents in a manner independent of the application software, hardware, and operating system. Each PDF file encapsulates a complete description of a fixed-layout 2D document that includes file)
- Retirement Plans FAQs regarding Designated Roth Accounts
- Additional Information on Roth 401k
- Roth401(k) Decision Matrix Roth 401(k) vs. Traditional 401(k)
Notes
- ^ http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00000402---A000-.html
- ^ Wait-and-see stance for Roth 401(k), Andrea Coombes 2005
- ^ A New Type of 401(k) Picks Up Steam, Jeff D. Opdyke 2006
Categories: Retirement in the United States Categories: Retirement | Politics of the United States | Internal Revenue Code This category is for articles related to the Internal Revenue Code, the primary domestic statute concerning taxation in the United States. It can be found in Title 26 of the United States Code
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