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Winter, 2009
Beginning in 2006 employers were able to offer Roth 401(k) accounts. Exisitng
401(k) plans had to be amended to offer this option. Like the Roth IRA,
the Roth 401(k) offers tax free income at retirement.
If your employer offers this
option, you will have some decisions to make. You will need to determine whether
to contribute to the traditional 401(k) or the Roth 401(k) or a combination of
both. To help you make these decisions you need to know how each plan works.
First of all, the maximum
contribution is $16,500 (for those age 50 or older the maximum contribution is
$22,000). This maximum amount can go into either of the accounts or be divided
between them in any combination not to exceed the maximum.
Next, the traditional 401(k) is
tax deferred, meaning contributions reduce your taxable income. Also, the
earnings on your contributions are tax deferred. Upon withdrawal at retirement
or earlier the total proceeds are taxable.
The Roth 401(k) is not tax
deferred. It is deducted from your salary after tax. It does not reduce your
current taxable income but when you withdraw it at retirement, it is totally tax
free including the earnings.
The traditional 401(k) creates
tax savings now while the Roth 401(k) creates tax savings at the back end.
Contributions to Roth IRA’s
are prohibited for taxpayers with adjusted gross income above $166,000 for joint
returns and $105,000 for single filers. There is no income restriction on
contributions to a Roth 401(k) account. Therefore, employees can contribute as
much as their company plan permits.
Your plan administrator must
keep 401(k) and Roth 401(k) contributions and earnings separately. Roth
401(k)’s cannot receive any matching employer contributions or forfeitures.
Roth 401(k)’s can only contain money from your after tax contributions plus
related earnings.
Because of company matching, you
may want to defer salary into the traditional 401(k) up to the point where the
company stops making contributions. You could then funnel the rest into the
after tax Roth 401(k).
In order for Roth 401(k)’s to
be tax free upon withdrawal, the account must have been open for at least five
years and you cannot withdraw before 59 ½ years of age. However, unlike the
Roth IRA’s, you must start withdrawing at age 70 ½.
If your employer offers both the
traditional 401(k) and the Roth 401(k) and you are not sure what to do, we can
help. Please provide us with the following:
- annual contribution
- amount of employer match
- tax bracket including state
- current age
- retirement age
- expected rate of return
We at G.R. Starbuck & Co. can look at your retirement options and help you
decide what will help you meet your financial goals.
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