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Roth 401k

Old 12-21-05, 10:20 AM
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Roth 401k

I'd heard about Roth 401k plans, but didn't realize they had materialized. I seriously doubt I would convert my 401k to Roth 401k (back in 1998 when Roth IRAs were created, you could convert from IRA to Roth IRA, spread your tax payments over 4 years and pay taxes at each years taxable rate) since the balance is rather large and I'd have to pony up a boatload of cash (even if it is spread out over 4 years)

Anyway, came across this article in WSJ, and thought it would be interesting to find out at what income/tax level it would make most sense to contribute to Roth 401k vs. 401k. It seems to me that if you're already in the highest tax bracket (or darn near to it) then it wouldn't make any sense to contribute to a Roth 401k (only because your tax rate can only go down but you're also making a bet that rates will remain the same from today until you retire). Likewise, if you're in the lower tax brackets and expect to make more money in the future, then contributing to this type of 401k plan would only benefit you.

Ah, a bunch of hocus pockus. This only further confuses the Joe 6 pack in his retirement options.

A New Flavor
For Retirement
It's Called a Roth 401(k) Plan,
And It May Be Better for Some,
Like Younger Workers, Parents
By JEFF D. OPDYKE
Staff Reporter of THE WALL STREET JOURNAL
December 17, 2005; Page B1

Get ready for yet another retirement-savings plan.

Come Jan. 1, a new entrant joins the list of options: the Roth 401(k). Workers considering this route must answer a simple question from Uncle Sam: Do you want to pay me now or pay me later?

Traditional 401(k) plans allow investors to sock away part of their income before it is taxed by federal, state or local authorities; the government takes its cut as retirees withdraw the money.

With Roth 401(k) plans, the money that is contributed is taxed now, but the withdrawals are tax-free.

So far, neither workers nor employers have shown much interest in the Roth plans. For workers, paying into a Roth 401(k) means less take-home pay than if they contributed a like sum to a traditional 401(k). For employers, offering the new plan means additional administrative chores.

Still, while Roth 401(k) plans aren't right for everyone, they are advantageous to lots of people in a variety of situations, including younger workers, folks with big estates to leave their heirs and even parents and grandparents saving for children's college education.

At its core, the Roth 401(k) is similar to the Roth IRA, which has grown into a popular way to supplement employer-sponsored retirement plans since it was introduced in 1998. You save after-tax dollars during your working years in a mutual fund or other investments and then withdraw the money -- including all the profits the savings generated -- tax-free, so long as the account has been open five years or more and you are at least 59 years old. (Unlike Roth IRAs, which aren't available to high-income folks, there are no income limits with Roth 401(k) plans.)

That tax-free growth is what differentiates the new Roth 401(k) from the old-fashioned 401(k). You will owe Uncle Sam nothing on years of compounded profits, which are likely to be the largest chunk of your account. With traditional 401(k) plans, you skip taxes today, but when you withdraw the money, you pay taxes at ordinary rates not just on the contributions but also on all of the compounded profits. That means a traditional 401(k) ultimately would provide a smaller amount of after-tax dollars to live on in retirement.

The other key advantage with a Roth 401(k) is that it allows savers to roll the value of the account into a Roth IRA, effectively creating a way to transfer assets to heirs tax-free. That is because, while the Roth 401(k) imposes a requirement that certain sums begin to be distributed from the account at age 70, the Roth IRA has no such rule.

Not many workers will have access to a Roth 401(k), at least initially. A survey over the summer by Hewitt Associates, the Lincolnshire, Ill., human-resources-consulting firm, found only 31% of 458 companies polled said they are "somewhat or very likely" to offer Roth 401(k) plans to their employees.

Big retirement-plan providers Principal Financial Group and Fidelity Investments each say interest in Roth 401(k) plans is modest among the corporate clients for which they manage retirement plans.

"Of the new plans we're signing up, less than 10%" are showing interest in the Roth 401(k), says Kevin Morris, marketing officer for Principal's Retirement Investment Services unit. Charles Schwab Corp. says it has signed up 51 companies that will begin offering Roth 401(k) plans on Jan. 1 and another 15 or so that will offer them later in the year, representing about 10% of the firm's total corporate clients.

All new retirement plans take time to catch on as savers digest the tax consequences and investment options. The Roth 401(k) is likely to be no different. Companies generally begin to offer particular benefits only after workers voice interest in them.

One company that will offer the Roth immediately is Plant & Flanged, a Blaine, Minn., supplier of water-treatment equipment. It met last week with its 17 employees to explain how the new retirement account will work. The company already offers a traditional 401(k) plan but opted to add a Roth, says co-owner Rod Ganther, "because if our company keeps growing, our people's income and investments grow, and they'll benefit later" in retirement when they will be in a higher tax bracket.

That is a key issue workers must grapple with in deciding between Roth and traditional 401(k) plans: What tax bracket might they fall into in retirement?

"Seeing what your tax rate might be in the future is difficult for most people," says Matthew Chope, a partner at the Center for Financial Planning, a Southfield, Mich., firm.

For younger workers, it is a no-brainer. Younger workers typically fall into a lower tax bracket today, and if they save for retirement for decades, they almost certainly will be in a higher tax bracket when they begin withdrawing their savings later. Younger workers "should definitely choose the Roth over a traditional 401(k)," says Bryan Lee, president of Strategic Financial Planning, in Plano, Texas.

While equal contributions in a Roth or traditional 401(k) would ultimately grow to the same size, the traditional 401(k) imposes taxes on all the profits and contributions on the way out. The Roth only taxes the contributions on the way in.

Still, that tax hit on contributions now could turn off some younger workers for whom the Roth is an otherwise better proposition. A worker in, say, the 25% tax bracket would have to come up with $20,000 before taxes to fully fund the $15,000 contribution limit in a Roth 401(k) for 2006. Moreover, money saved via the tax break on a traditional 401(k) could be invested in another retirement vehicle, offsetting the Roth 401(k) advantage.

Saving in a Roth 401(k) generally isn't a great strategy for older workers with little savings. Those moving into their 50s generally don't have enough time remaining in the work force to benefit significantly from the tax break on the compounded growth of their profits.

In a pamphlet Principal Financial distributes to workers in plans it manages, the Des Moines, Iowa, retirement-services firm advises against the Roth 401(k) "if you are uncertain, or know you will be in a similar or lower tax bracket at retirement." The reason: You get a bigger tax break from a traditional 401(k) by saving pretax dollars today while you are in a higher tax bracket and then paying taxes at a lower rate later in retirement.

Older workers who know they will be in a higher tax bracket -- essentially those who already have or expect to have a large nest egg that will generate substantial income in retirement -- are likely to benefit from a Roth 401(k). They will get a bigger break by paying taxes at a lower rate today, rather than waiting to pay the higher tax rate they would face with traditional 401(k) distributions later.

Some older workers who may not be prime candidates for a Roth might want to start one, anyway, perhaps with just a token amount of their overall 401(k) contribution. That way, if their salary increases unexpectedly, they would have the Roth account in place in the event Congress ultimately decides not to allow the creation of anymore new ones. The law that created the Roth 401(k) is set to expire at the end of 2010, so Congress would have to extend it or make it permanent to allow new ones after that.

Older parents or grandparents saving for a child's college education can also benefit from a Roth. If you have at least five years to go before the child enrolls, and you will be at least 59 at that point, you will be able to pull money from the Roth tax-free to pay school bills. Whatever is left remains yours and, unlike a 529 college savings plan, doesn't have to be used for education expenses. Moreover, retirement accounts generally aren't counted as assets in federal financial-aid formulas, potentially helping a student obtain a larger slug of financial aid.

Write to Jeff D. Opdyke at [email protected]

Last edited by ChiTownAbs, Inc; 12-21-05 at 10:28 AM.
Old 12-21-05, 10:45 AM
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I want a Roth 401(k)!

I have a traditional 401(k) and a Roth IRA.
Old 12-21-05, 11:13 AM
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My firm is rolling this out as well. I'll probably participate.
Old 12-21-05, 11:30 AM
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Just asked our benefits coordinator. He said we should be getting them 2nd or 3rd qtr of 2006.
Old 12-21-05, 11:47 AM
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This sentence from the article pretty much sums up why I want a Roth 401k:
You will owe Uncle Sam nothing on years of compounded profits, which are likely to be the largest chunk of your account.
Lets be honest. Taxes hardly ever go down and when they do its only temporary. Who know what they'll want to take by the time I'm ready to retire?
Old 12-21-05, 12:03 PM
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Wait --- so I could roll my current 401(k) into a Roth 401(k) and not pay taxes upon withdrawal?
Old 12-21-05, 12:16 PM
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Originally Posted by The Bus
Wait --- so I could roll my current 401(k) into a Roth 401(k) and not pay taxes upon withdrawal?
Maybe you'd pay some additional taxes up front?
Old 12-21-05, 12:27 PM
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Originally Posted by The Bus
Wait --- so I could roll my current 401(k) into a Roth 401(k) and not pay taxes upon withdrawal?
I don't think you can roll 401k -> Roth 401k. If you did, it would be similar to the arrangement in 1998 which was you'd pay your taxes over 4 years.
Old 12-21-05, 12:54 PM
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Originally Posted by ChiTownAbs, Inc
I don't think you can roll 401k -> Roth 401k. If you did, it would be similar to the arrangement in 1998 which was you'd pay your taxes over 4 years.
I hope so!! I've got around $90K in my 401(k) but given I'm 29, it will be much more substantial later in life.
Old 12-21-05, 01:05 PM
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mine is very close, and given that i'm in a high tax bracket as it is, i will pay upwards of $30k over 4 years to move over.

if i were to do this, i'd just keep the 401k at the current rate and just contribute to a roth 401k
Old 12-21-05, 02:06 PM
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can someone explain the core differences between a regular roth IRA and the roth 401k? im confused.
Old 12-21-05, 03:27 PM
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ROTH IRA - Max Contribution $4,000 after tax dollars
- Contribution amount decreases as your income rises


ROTH 401K - Max Contribution $15,000 after tax dollars

- You can make a max contribution regardless of how much money you make.
Old 12-21-05, 07:20 PM
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I've asked about this at my company, but it sounds like we won't be getting the option.

In the post above, your contribution amount for roth IRA doesn't start decreasing until you are making around 90k which isn't the case for most people.
Old 12-22-05, 08:21 AM
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Originally Posted by asabase
In the post above, your contribution amount for roth IRA doesn't start decreasing until you are making around 90k which isn't the case for most people.
Depends on where you live.
Old 12-22-05, 11:23 AM
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Isn't this a moot point if Roth 401(k)s disappear in 2010? Or has the sunset date changed?

I put together a quick comparison spreadsheet for anyone who wants to do the simplified math. It does have some limitations, as it makes these assumptions:
  • There are no calculations for FICA, Social Security, State Taxes, etc. Just Federal tax.
  • Your pre-tax contributions will remain the same regardless of which option you have.
  • Your contributions are dollar-based, not a percentage of income.
  • Your contributions will either remain the same until retirement or increase each year at a pre-determined dollar amount.
  • There is no employer matching or profit sharing.
  • The rate of return remains constant through retirement.

Download: [401(k) Calculations Excel File]
Old 12-22-05, 12:17 PM
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Thx for the spreadsheet!

According to your calcs the Roth would give me 300k more at retirement. Not as much as I thought but still a significant number.
Old 12-22-05, 12:35 PM
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One thing to consider is that you can control the amount that you withdraw during retirement. Suppose you own a home that is worth $1 million at retirement (which isn't that far fetched) and you sell that home. You can take the cash and stick it in your savings account and use that as an annuity to pay your nursing home or condo.

(Then again, how many people can successfully move from a million dollar home to a condo? Probably very few.)

If you needed additional money, then you could tap into your 401k plan and keep the distributions at a very low tax rate.
Old 12-22-05, 02:23 PM
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Originally Posted by CPA-ESQ.
ROTH IRA - Max Contribution $4,000 after tax dollars
- Contribution amount decreases as your income rises


ROTH 401K - Max Contribution $15,000 after tax dollars

- You can make a max contribution regardless of how much money you make.
if thats the case, then why would anyone do a ROTH IRA instead of a ROTH 401K - the 401K seems far better. whats the advantage of a ROTH IRA?
Old 12-22-05, 03:31 PM
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You can do both (IRA and 401k). Very generally speaking, you want to do your company match to the 401k, then max your ROTH IRA, then go back and try to max your 401k if you can.
Old 12-22-05, 04:29 PM
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Originally Posted by atari2600
if thats the case, then why would anyone do a ROTH IRA instead of a ROTH 401K - the 401K seems far better. whats the advantage of a ROTH IRA?
You can only participate in a 401K if your employer offers one. If your employer does not offer a 401K then your only retirement options are the ROTH IRA or a traditional IRA ($4,000 max per year) if you are not self employed.

If your employer does not offer the new ROTH 401K then your only ROTH option will be the ROTH IRA
Old 12-22-05, 09:25 PM
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Originally Posted by The Bus
Isn't this a moot point if Roth 401(k)s disappear in 2010? Or has the sunset date changed?
Can someone answer that? I hope not!
Old 12-22-05, 09:32 PM
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I've badgered my company about offering them next year, and their response was, until this 5 year sunset is removed by congress, they're not going to offer one because there are too many uncertainties.

They make a good point, WTF would Congress pass retirement plan legislation, then have it automatically cancel out after 5 years?
Old 12-22-05, 09:57 PM
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as of now, it's still set to expire in 2010.

here is a great site I stumbled upon one day

http://www.roth401k.com/

also, check out:

http://www.lifetimesavingsaccount.com/
Old 12-22-05, 10:24 PM
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Being in the financial services industry, I cannot believe how shitty my retirement options are.

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