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The Roth 401(k)

The Economic Growth and Tax Relief Reconciliation Act that became effective in 2006 did for 401(k) plans what the US government did for individual retirement accounts a few years earlier: it established a Roth version. Employers who provide 401(k) plans to their employees now have the option to offer this new version as well. Essentially, the Roth 401(k) works the way a Roth IRA works. Any contributions made to the plan are not eligible for tax deduction. However, when the funds are withdrawn (provided that you are at least age 59½ and your account is at least five years old), they are not taxed. An extra bonus is that any growth in the account, whether by appreciation or earnings that you reinvested, is also not taxed.

There are no yearly income limits that you must fall under in order to contribute to a Roth 401(k), as there are for a Roth IRA. Also, you may contribute to both a standard 401(k) and a Roth 401(k), provided that you do not exceed the yearly maximum.

Employers may contribute matching funds to their employees' Roth 401(k)s. However, these matching funds are not after-tax, like the contributions made by employees. They are before-tax, meaning that they must be kept separate from Roth account funds. Upon withdrawal, then, the matched portion of the account will be subject to federal income tax.

A Roth 401(k) can be advantageous if you expect to be in a higher tax bracket after age 59½.

As with standard 401(k)s, you will be penalized for taking withdrawals before age 59½. You will also be required to take distributions beginning at the age of 70½. On your income tax forms, your Roth distributions will not be counted as income; those matched by your employer will be.

Is the Roth 401(k) for you? It can certainly be advantageous if you expect to be in a higher tax bracket after age 59½ than you are today. Thus, it may help for you to determine whether tax breaks now or tax breaks later in life will be more important.

Even if you are unsure about your future tax rates, a Roth 401(k) might still be to your benefit. It may be worthwhile to consult a financial planning professional who will work through a variety of hypothetical scenarios with a computer to help you make an informed decision.