Roth 401(k) Benefits Baby-Boomer Tills

Rich baby boomers now have a chance at a Roth investment, too. And they can put more money into it with the same tax-free benefits.

That’s the gist of the new Roth 401(k) that will become available in 2006, thanks to the Economic Growth and Tax Relief Act of 2001.

Phillip French, a CPA and pension specialist for Moore Stephens Frost Financial Group in Little Rock, said the new 401(k) option isn’t for everyone.

“If you anticipate a lot of taxable income in your retirement years, the Roth 401(k) makes sense,” French said. “It’s the same principal as choosing between a deductible and a Roth IRA, so it applies to both.”

French said those who would best benefit are those with higher incomes or the self-employed who are trying to maximize tax benefits from the 401(k), and who will be in a tax bracket that is high, or nearly as high, in retirement years.

Dale Brunk, a financial adviser with Beall Barclay & Co. PLC in Forth Smith, said he hasn’t actually seen any clients sign up for the new Roth option yet. French said the same.

Brunk said the advantage of the Roth 401(k) over the traditional Roth IRA is “eligibility” for some. Traditionally, taxpayers in high-income brackets were excluded from the benefits of the Roth IRA, which allows filers to make contributions with after-tax dollars and earnings can be taken out tax-free after age 59-and-a-half.

That’s so long as the IRA has been open five or more years. The Roth 401(k) also allows after-tax contributions and isn’t subject to income tax after five years for those 59-and-a-half and older. If an account holder takes money out of a 401(k) or Roth IRA account before age 59-and-a-half that money is subject to a 10 percent tax penalty.

To be eligible to contribute to a Roth IRA, single filers cannot have an annual adjusted gross income of more than $160,000 and the eligibility starts to phase out at the $95,000 to $110,000 range, Brunk said. Joint filers cannot make more than $200,000 and eligibility starts waning in the $150,000 to $160,000 range.

Essentially, after-tax dollars are worth more later than they are pre-tax because pre-tax dollars will shrink as you pay taxes on them, French said.

“If someone is trying to maximize what they are putting in, putting the dollars into a Roth 401(k) helps you maximize it because those dollars are worth more because they are tax-free dollars,” French said. “The entire account is never taxed, which it is in the traditional 401(k), upon distribution.”

In addition, contribution limits are higher with the new Roth.

Roth 401(k) contribution limits, or salary deferals, top out at $15,000 in 2006, with a catch-up provision for those over 50 capped at an additional $5,000.

By contrast, a traditional Roth IRA has a 2006 contribution limit of $4,000 with a catch-up limit of $500.

The Roth IRA, which became available in 1998, was named after the late Sen. William V. Roth Jr., R-Del., who introduced its bill.

“What we see is most business owners want tax deductions,” Brunk said. “Which is what they get with the new Roth 401(k): the ability to sock away money, be taxed on it earlier rather than later and at a higher income bracket. A traditional 401(k) isn’t taxed.

“The advantage of the Roth is that you pay the taxes now so that when you retire you’ve pulled the money out and you don’t apply any taxes on the money, or the earnings you’ve accumulated.”

However, the new Roth 401(k) leaves some unanswered questions. It is scheduled to sunset in 2011, which only leaves four years of contributions and less opportunity for growth, Brunk said.

In addition, employer resources will be more taxed, Brunk said.

“That’s one of the things I’ve advised my clients,” Brunk said. “We can set [a Roth 401(k)] up and utilize it for four years, but we don’t know what is going to happen after that.

“It will be an extra step for payroll and an extra step at the investment level and an extra step at the reporting level.”

Brunk said it was up to the employee plan administrator to keep funds such as 401(k) and Roth 401(k) separate.

The regulations aren’t final on the Roth 401(k) and should be issued by the Internal Revenue Service by the end of the year, French said.