For a while now on this site you've heard me extolling the virtues of the Roth IRA, talking about how I think it should be a part of any person's investment plan, and how it's a great tool to help diversify your retirement savings. When I have written the posts I've mostly focused on the Roth IRA because that's the main avenue we've taken part in for our own investing. We would have liked to invest more, but some unforeseen (and foreseen – the baby) medical events in the past couple of years have kept us from investing too much.
Now that we're starting to have a bit more free money to save and invest we're looking more at the options we have available to us. My company recently made some changes to the company 401(k)plan moving to a new plan administrator. With the move we're going to have a lot better low cost investing options in our plan with some good index funds from Vanguard now available, as well as there now being a completely new Roth 401(k)option.
Because we now have more and better choices our investing path will be slightly different. Here's what we'll be doing now:
- Invest in Roth IRA to max: First, we would like to invest in our Roth IRA to the max of $5000 per investor. So that means $5000 for each of us, my wife and I. Little Carter has no earned income so he'll have to wait. :)
- Invest in company 401(k) & Roth 401(k)to max: Next we’ll be investing in my company 401(k)and Roth 401(k)to the max. For 2011 that means a combined total of $16,500.
- Investing in taxable accounts: Next we would be investing in taxable investments, most likely through an account with Betterment.com, ING Direct Investing or one of the other discount online brokerages. That may not be happening much this year since we're also trying to save for a down payment for a house.
The History Of The Roth 401k
The Roth 401(k) is a type of retirement savings plan. It was authorized by the United States Congress under the Internal Revenue Code, section 402A, and represents a unique combination of features of the Roth IRA and 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) retirement plans. The Roth retirement plan provision was enacted as a provision of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA 2001).
Roth 401(k) Contribution Limits
The Roth 401(k) is subject to the same contribution limit as the regular 401(k). For 2011 that means there is a contribution limit of $16,500. If you are 50 or older the limit is bumped up to $22,000.
Note: The Roth 401(k) and the regular 401(k) are subject to the same contribution limit. In other words the total contribution for both account types is $16,500. You can't contribute $16,500 to one account and then an additional $16,500 to the other. So the Roth 401(k) offers no new opportunity to invest, just the opportunity for a different tax treatment than the regular 401k.
Roth 401(k) Withdrawals
I would never suggest taking money out of a retirement plan before you actually retire, but in some cases of hardship and so forth it may be necessary. Here are the rules for taking distributions from your Roth 401k(k) account.
In order to withdraw your money without tax penalties you need to have had the account for at least 5 years as well as being at least 59½ or disabled. Required minimum distributions begin at age 70 1/2, unlike the Roth IRA which has no RMD.
If you need to take the money out for other reasons and you don't meet the above criteria (5 year account/59.5 years), then you will see penalties. For the Roth 401(k) you have to report taxable income in proportion to the account's earnings when you take a distribution.
For example, if 70% of the money in the account is from your contributions and another 30% is from earnings, your distribution will be 30% subject to taxes and penalties even if the amount you withdraw is less than the amount of your contributions. This sets it apart from the Roth IRA which allows tax free withdrawals of your contributions at any time. So again, there will be a 10% penalty and the regular tax rate charged on the proportion of your early withdrawal that is attributable to earnings.
The situations where you can take a non-qualified distribution are limited, so seek tax advice when heading down that road.
Benefits Of Roth 401k
The Roth 401(k) has several benefits that should be noted.
- Higher contribution limits than the Roth IRA: While the Roth 401(k) has the same after tax contributions, it has a higher contribution level than the Roth IRA which tops out at $5000/year.
- Rollover option: If you leave a company you can roll a Roth 401(k) directly over into a Roth IRA.
- Good for high income individuals: High income individuals are limited when it comes to contributing to a Roth IRA. No such limitations exist for Roth 401(k).
- Post tax contributions mean you pay no more tax: Like the Roth IRA you won't be paying any further tax on the money or earnings in retirement. It's a good way to diversify tax risk.
The Roth 401(k)combines some of the great parts of the Roth IRA – the tax free withdrawals at retirement – with the higher contribution limits of the traditional 401k. Because of that it's a great choice for a wide variety of investors, as long as their company's plan offers the Roth 401(k)as an option – which not all of them do.
Do you have a Roth 401(k)option in your plan, and are you taking advantage of it? Tell us your thoughts on the Roth 401(k)in the comments!