Roth 401(k) FAQs |
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September 29 , 2005 |
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The Roth 401(k) is the hottest new retirement product to come along in quite a while. Although it is not available until 2006, clients have already been asking questions about this new option and when it will be available. We'd like to share our answers with you. |
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| What is the basic difference in the concept of a Roth 401(k) deferral versus a “traditional” 401(k) pre-tax deferral? | ||
| With a Roth 401(k) deferral, the deferral amount is made in after-tax dollars. Also, the earnings on the Roth deferrals will be tax-free if the contributions remain in the plan for at least five years after Roth deferrals commence and the participant does not take withdrawals before attaining age 59½ (death and disability also qualify). A traditional 401(k) deferral is tax deferred at the time of contribution and both the deferral and the earnings on the deferral are taxable when distributed. | ||
| How much can be put in a Roth 401(k)? | ||
| The 402(g) limit applies to both Roth 401(k) and traditional pre-tax deferrals. In 2006, the maximum deferral amount is $15,000, and participants who are 50 or over may make additional catch-up deferrals of up to $5,000. The total of an individual's pre-tax deferrals and Roth deferrals may not exceed the overall 402(g) limit (plus catch-up limit, if applicable) in effect for the calendar year. | ||
| May the participant make both pre-tax deferrals and Roth 401k deferrals in the same year? | ||
| A 401(k) plan may be designed to permit both the pre-tax deferrals and the Roth 401(k) after tax deferrals. | ||
| When must the participant elect to make a Roth deferral? | ||
| The decision to characterize the deferral as a Roth contribution is made at the time the contribution is made and the decision is irrevocable. | ||
| Does the Roth contribution have to stay in the plan for five years in order for the earnings to be tax-free? | ||
| Yes. To withdraw the earnings tax-free, the Roth contribution must remain in the plan for at least five years and the participant must have attained age 59½ (death and disability also qualify). | ||
| Does the five-year period start as of the time of the first Roth contribution; or does each year’s Roth contribution have to be in the plan for five years before it is eligible to be withdrawn without taxation on the earnings? | ||
| The five-year period is determined starting as of the date of the first Roth contribution. A Roth contribution in a subsequent year does not start a new five-year period. | ||
| How are the Roth and pre-tax deferrals accounted for in the plan? | ||
| The Roth and the pre-tax deferrals must be separately sourced and must be record kept separately. Earnings on the Roth contribution must be record kept separately from earnings on the pre-tax deferrals. | ||
| Where are the Roth rules found? | ||
| The Roth 401k option was authorized as part of Economic Growth and Tax Relief Reconciliation Act (EGTRRA), which added section 402A to the Internal Revenue Code. In addition, the IRS has issued proposed regulations to implement Roth 401ks. We are awaiting the finalization of these regulations and issuance of guidance on model plan language (LRMs) before adding relevant provisions to our plan documents. | ||
| May a 403(b) arrangement have Roth 403(b) contributions? | ||
| Yes, however, we are also awaiting the release of guidance on Roth 403(b) plan rules. | ||
| When will Roth 401(k) plan documents be available? | ||
| EGTRRA stated that Roth 401(k) contributions may not be made until 2006. Thus, no one can open a Roth 401(k) in 2005. We are also awaiting guidance from the IRS addressing the final regulations and providing model plan document language in order to incorporate Roth 401(k) provisions into a plan document. Until this language is issued, no one can provide an IRS authorized 401(k) Roth plan. As soon as IRS issues the model language and final regulations, we will make a Roth 401(k) amendment available. We still hope that this guidance will be released very soon so employers may make a Roth 401(k) available for January 1, 2006. Stay tuned for further developments. | ||
| Roth IRAs have an income limit for eligibility to make contributions. Are there income limits on Roth 401(k) contributions? | ||
| No. Unlike the Roth IRA, where people whose adjusted gross income (AGI) exceeds certain limits are not eligible to make Roth IRA contributions, all participants in a qualified plan may make Roth 401k contributions regardless of the individual’s AGI. | ||
May an individual have both a Roth IRA and participate in Roth 401(k) plan? |
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| Yes. | ||
| May catch-up contributions be made as Roth contributions? | ||
| Yes. | ||
| Are Roth 401(k)s part of the sunset provisions of EGTRRA? | ||
| Yes. Roth 401(k)s are part of EGTRRA which sunsets in 2011. Congress will need to pass legislation to make the provisions of EGTRRA permanent before EGTRRA sunsets, | ||
| May matching contributions be made on Roth contributions? | ||
| Yes. However, the matching contributions are tax-deferred rather than exempt from taxation. | ||
| What happens if the Roth funds are withdrawn prior to five years and age 59½? | ||
| Generally, the earnings are taxable and subject to penalty. | ||
| If Roth contributions are permitted in the plan, is it a given that younger workers will benefit more from the Roth contribution then from the pretax contribution? | ||
| There are so many variables that it is impossible to generalize. Each participant must take into consideration his or her own personal circumstances. | ||
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