The Roth 401(k) Feature

Add comment March 31st, 2008

  John D. Schissel, QPA, CPC 

The ability to make Roth 401(k) contributions became available to companies starting in 2006. The Pension Protection Act eliminated the original 2010 sunset provision and this benefit is now steadily picking up momentum as employers now regularly add this feature. 

Roth 401(k) allows participants to tax their earnings when they are made to the plan. When Roth deferrals are withdrawn (assuming you meet certain minimal requirements) these deferrals and all of the earnings are received tax free. 

On an economic basis, these two alternatives –Roth and Traditional- will work out exactly the same if the participant remains in the same tax bracket in retirement as they are when the deferrals are made. 

Many selecting Roth contributions believe tax rates will increase based on recent government spending patterns; they anticipate being in a higher tax bracket in retirement and believe the solutions to Social Security and Medicare funding will raise the tax burden. Having the ability to pay the tax bill currently to allow investment earnings to compound over many years completely tax free is a great benefit. Assets in the Roth accounts are also not subject to minimum distributions of pre-tax contributions.  So, you can gift all of the tax-free returns to your heirs. Generally, the longer investment period, the more advantageous the Roth is. 

It is a good idea to do a sample calculation of the investment results of traditional vs. Roth 401(k’s).  Some participants do both.  If your current plan does not permit the Roth feature, consider asking your employer to add the feature.