Roth 401k

Effective January 1, 2006, businesses looking for an employee retirement plan have a new option: the Roth 401k. If the name sounds familiar, that's because it is. The Roth 401k combines the Roth IRA's power of tax-free withdrawals with the flexibility and investment options of a traditional 401k plan.

The Roth 401k plan, like the Roth IRA, requires after-tax contributions. This means participants can only use funds from take-home pay. However, this allows participants to withdraw funds tax-free after age 59½. It also permits far more than the limit for personal IRA accounts ($4,000 in 2006; $5,000 if someone is over 50 years old). Under the plan guidelines, participants can continue contributing to existing or new Roth IRA accounts while investing in a Roth 401k.

If you decide to offer a Roth 401k and you match employee contributions, the amount you contribute are still made with pretax dollars. They are kept in a separate account and taxed upon withdrawal.

Similarities to traditional 401k
The limits for a Roth 401k are very similar to a traditional 401k allowing you to maximize your retirement savings potential. You can contribute up to $15,000 with a catch-up provision of $5,000 extra if you're over 50. Keep in mind a Roth 401k isn't an opportunity to circumvent IRS regulations and double your annual contributions. You're allowed to maintain both traditional and Roth versions of a 401k, but you can only contribute up to the annual limit for both plans combined.

Among the other similarities:

• Rollovers are permitted
• Participants can begin withdrawing funds after 59 ½
• Participants are required to withdraw funds after 70 ½
• Employees can leave your company and keep vested funds in your plan but can't make further investments
• Withdrawing funds early incurs a 10% penalty and taxes on any potential gains
• If you permit loans, participants can withdraw funds but must have a qualifying event (retirement, termination of service, financial hardship)

What does the future hold for Roth 401k?
The Roth 401k plan is still in its infancy so it's too soon to determine how it will change over the years. It will exist in its current format until 2010. After that, it's possible the plan could be dissolved or simply merged with a traditional 401k plan if it's not successful. Should that happen, participants wouldn't be able to contribute funds to that account, but existing contributions and gains would remain and continue to grow until withdrawal.