Is the Roth 401(k) Right for You?

In January 2006, some companies will begin to offer the new Roth 401(k) retirement plan to employees. The plan is a combination of the traditional 401(k) and the Roth IRA and has many attractive features, but is it right for you?

What is the Roth 401(k)?

A Roth 401(k) is a work-related retirement plan that will allow you to contribute up to $15,000 ($20,000 if you are over 50) of unmatched post-tax income. Upon retirement, withdrawals are not subject to further taxation. In contrast, a traditional 401(k) has the same contribution levels, but contributions are made with pretax dollars and are often matched by your employer.

Who can benefit by contributions to a Roth 401(k)?

If you are already well-prepared for retirement and are setting significant funds aside for the future, investing in a Roth 401(k) will ensure that you are not bumped into a higher tax bracket in retirement because withdrawals from a Roth 401(k) are not considered income.

If you are currently in a low tax bracket, invest in a Roth 401(k). This way, if taxes increase in the future, you will be gaining a significant tax break by paying taxes on your income now.

If you are already contributing the maximum allowable to your 401(k), begin to contribute to a Roth 401(k) instead. Higher-income workers will not have a difficult time contributing post-tax earnings at a significant rate.

Additionally, if you are a higher-income worker who earns too much to open a traditional Roth IRA but who wants the benefits afforded by a Roth IRA, you are qualified to contribute to a Roth 401(k) and reap the same benefits. (If you are married and earn $140,000 combined, or if you are single and earn $110,000, you cannot contribute to a traditional Roth IRA.)

Who should not contribute to a Roth 401(k)?

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If you are currently contributing small amounts of your income, or no income at all, toward retirement, then a Roth 401(k) is not for you.

In addition, if you are a commissioned salesperson and are earning an unusually high income that is not likely to last, then you will probably find yourself in a higher tax bracket now than you will in retirement. It will be better for you to take your tax break now than later, so a traditional 401(k) would be a better option.