Show #324 Airing Sunday, 1/1/06
There’s an extra reason to be celebrating the arrival of 2006. Starting today we have an exciting new way to save for retirement. It’s called a Roth 401(k). Here to ring in the news on this new money-saving benefit is an old friend, Jim Lineweaver.
Question: I understand a new retirement option goes into effect today. Can you explain?
Answer: Most of the more than 400 new tax rules created by 2001’s Economic Growth and Tax Relief Reconciliation Act went into effect years ago. However, one item that will substantially change the retirement plan market will go into effect today—the Roth 401(k).
The Roth 401(k) combines elements of the traditional 401(k) with the tax benefits of the Roth IRA. One can now contribute to tax-deferred savings accounts with after-tax dollars in exchange for the benefit of withdrawing that money tax-free in retirement.
Question: Will the Roth 401(k) be readily available?
Answer: Estimates show that more than 30 percent of employers surveyed said they were very or somewhat likely to offer a Roth 401(k) this year.
Question: How will it work?
Answer: Those with access to both a Roth and a traditional 401(k) will be limited to the same contribution cap as people with just one 401(k). The cap for 2006 is $15,000 or $20,000 for those 50 and over.
This leaves workers with three choices: Contribute solely to the traditional 401(k), divert contributions to the Roth 401(k), or split contributions between the three accounts.
Question: How can someone saving for retirement decide whether or not a Roth 401(k) will work for them?
Answer: You have to take a close look at what you think your personal tax situation will be in retirement. Generally, the Roth 401(k) is a good solution for those who expect to be in a higher tax bracket in retirement.
You may also want to consider what the national tax picture might look like come your retirement, though that is really a shot in the dark. If taxes head higher to pay off the national debt—and many tax professionals predict that—paying taxes now, as in the Roth 401(k) is a good deal. If the government dumps the current tax system in exchange for a lower flat tax or a sales tax—ideas gaining some traction in recent years—those with Roth 401(k) might lose big.
Question: You mentioned that those who might find themselves in a higher tax bracket might find these 401(k) especially beneficial. Why might someone who is highly paid benefit more from a Roth 401(k)?
Answer: It marks the first time those with higher incomes will have access to a savings account that offers tax-free withdrawals in retirement. The only other savings account that currently offers that benefit, the Roth IRA, carries strict income stipulations.
Tax rates are currently quite low for those with higher incomes, which improves the chance that rates will be higher for this group come retirement.
The Roth 401(k) may present a unique estate-planning benefit for wealthier people, because there’s generally no required minimum distribution age. With traditional 401(k) or IRAs, the government requires minimum distributions st arting at age 70 ½ to ensure people eventually pay some tax on the money.
The all-new Roth 401(k) offers yet another option for retirement planning. To find out if it might work for you, give Jim a call.