by Sidney J. Ruth, CPA/Financial Advisor*
There were more than 400 new tax rules in the Economic Growth and Tax Relief Reconciliation Act of 2001(EGTRRA). Most of those laws went into effect years ago, but the time has finally arrived for one provision, which may substantially alter the future of 401(k) and 403(b) plans. Beginning January 1, 2006, sponsors of 401(k) and 403(b) plans may allow participants to make Roth contributions within their retirement savings plans. The Roth 401(k) allows after-tax contributions to fund tax-free retirement income.
Features of the Roth 401(k) and 403(b)
• The elective contribution limit is the same as for the regular 401(k) – $15,000 in 2006, plus $5,000 catch-up limit for those 50 years and older. This contribution limit applies to the total of Roth and Non-Roth contributions – the employee does not get to “double-dip.”
• Distributions from the Roth account are tax-free as long as the participant is age 59½ or older, and their account has been open for at least five years.
• Separate Roth accounts must be maintained. Roth contributions are treated the same as regular contributions for plan testing purposes.
• All employer matching and/or profit-sharing contributions must continue to be made to the employees’ pre-tax account.
Who Should Consider Roth Deferrals?
• High Income Taxpayers – who would not qualify for an individual Roth IRA
• Younger and Lower Income Taxpayers – who currently receive little tax subsidy with respect to pre-tax deferrals
• Professionals/ Business Owners – Qualified plans may be the most protected asset in the U.S., and any financial plan for a professional or business owner must seriously consider maximizing these assets for the protection they offer
• Estate Planning Considerations – The new Roth 401(k) could be a highly effective estate-planning tool for high-income earners and business owners, potentially allowing participants to stretch assets and minimize taxes for decades
• Tax Diversification – 401(k) and 403(b) participants, who want to diversify long-term tax risk, should consider Roth contributions. In an environment where tax rates and laws seem to change with the seasons, tax diversification should serve as the foundation for plan sponsor and participant decision-making regarding the Roth 401(k)
Potential Changes in Tax Code
An important assumption in our analysis is that Roth withdrawals remain tax-free in retirement. However, Congress could always change this rule, just as it could any other aspect of the tax code. Currently, the Roth 401(k) and all of the provisions of EGTRRA are set to expire after December 31, 2010, unless they are extended by Congress.
Although the new Roth option for 401(k) and 403(b) plans presents many exciting planning opportunities, it is not appropriate for everyone, and may only lead to further complication and paralysis among qualified plan participants. Employers looking to add the Roth 401(k) option to their plan, or those who would like to evaluate their current retirement plans, should consult with the retirement professionals at FIFS by calling 267-384-5300.
*Investment advisor representative of Investment Advisors, a registered investment advisor and a division of
ProEquities, Inc. • Securities offered through ProEquities, Inc., a registered broker-dealer. Member NASD and SIPC.
1110 North Main Street, Goshen, IN 46528 (574) 533-9511. FIFS is independent from ProEquities, Inc.
FIFS Connection, Winter 2006, Vol.3, No. 1
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