A New Way to Save

Employers are now able to offer their employees a Roth 401(k), which combines the tax-free withdrawal aspect of a Roth and the higher contribution level of a 401(k).

By Cameron Huddleston, Contributing Editor, Kiplinger.com

January 11, 2006

More than 14 million American households have opened Roth IRAs since they were first offered in 1998. Tax-free and no mandatory withdrawals helped feed interest in these retirement savings accounts. The only complaints in the past seven years have been that many high-income people cannot participate in the savings plans and those who can may only contribute $4,000 per year.

But those who don't qualify for Roths, or who want to save more, may soon get satisfaction. Starting in January, employers now are able to offer their employees a retirement savings plan that combines the 401(k) and Roth IRA. The Roth 401(k) will offer the same contribution amounts as traditional 401(k)s, but will grow tax-free and eanrings won't be subject to income taxes when withdrawn in retirement.

Although this new hybrid account might be appealing, it might not be widely available. About a third of 440 employers surveyed by human resources consulting firm Hewitt Associates said they were very likely or somewhat likely to offer the Roth 401(k).

Many employers are taking a wait-and-see approach, said Lori Lucas, director of participant research for Hewitt Associates. They want to make sure there is enough employee interest before going through the effort to make the Roth 401(k) available. So, Lucas says, "if workers are interested, they should make it known because there are employers sitting on the fence."

But even if your employer does offer the Roth 401(k), you may only be able to contribute to the account for just four years.

"You've got a short window to take advantage of it," says Rick Meigs, president of 401khelpcenter.com. That's because the Roth 401(k), along with all the other provisions in the 2001 tax law, expire in 2010.

But, Meigs says, lobbying groups are pursuing extensions for all pension-related portions of the law. Even if the life of the Roth 401(k) isn't extended beyond 2010, those who contribute to one won't lose their accounts, Lucas says. They just won't be able to contribute any more.

How it works

Eligibility. Employees who are eligible for their employer's 401(k) plan also would be eligible for a Roth 401(k). Unlike a Roth IRA, there isn't an income limitation. However, the amount highly compensated employees can contribute to a Roth 401(k) may be limited if their employer places a similar limit on traditional 401(k) contributions.

Contributions. Contributions are made with after-tax dollars, whereas contributions to a traditional 401(k) are made with pre-tax dollars. The maximum amount an employee can contribute to a Roth 401(k) is the same as for a traditional 401(k): $15,000 in 2006. Employees 50 and older can make an additional $5,000 catch-up contribution, for a grand total of $20,000. Contributions can be split between the two types of accounts, and funds will be held separately. However, the contribution limit is for both accounts combined, not individually.

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