Published January 2006

New retirement tool for 2006: Roth 401(k)

As 2006 begins, you’re now a year closer to retirement. Even though that day may still be a long time away, it will eventually arrive — so you’ll need to prepare for it. And effective immediately, you may now have one more retirement savings vehicle to work with: the Roth 401(k).

Just like a regular 401(k), a Roth 401(k) allows you to spread your money among a variety of investments. But there are differences between the two types of 401(k) plans. When you invest in a traditional 401(k), you generally contribute pre-tax dollars, which means you are not taxed on your contributions today. These contributions and your earnings will be taxed when you withdraw them at retirement.

By contrast, using the Roth feature in your 401(k) allows you to contribute after-tax dollars, which means you pay taxes on the dollars contributed right away. However, at age 59-1/2 your withdrawals and earnings will be tax-free (provided you’ve had the account for at least five years when you retire).

Furthermore, if you leave your job, you can roll over the Roth portion of your 401(k) into a Roth IRA — and Roth IRAs don’t force you to take required minimum distributions after you turn 70-1/2, which could be a big advantage if you won’t need the money until later in your retirement years.

And here’s one more advantage of the Roth 401(k): Unlike the Roth IRA, there are no income restrictions attached to it. Persons in any income bracket can contribute to the Roth 401(k).

However, it’s important for me to note that some employers may not even choose to offer the new Roth feature in their company’s 401(k). But if the option is available to you, should you contribute? Before deciding, consider these factors:

• Your age — The younger you are, the more advantageous it may be to contribute some of your 401(k) dollars into the Roth portion of your plan. As a young worker, you’ll have more years to take advantage of the tax-free earnings potential provided by the Roth feature. This additional time helps compensate for the cost of having to fund your plan with after-tax dollars.
• Your tax bracket at retirement — If you expect to be in a high-income tax bracket when you retire, you may find the Roth 401(k) to be particularly appropriate. The value of being able to withdraw tax-free is worth more if you’re in a high bracket.
• Your willingness to divide 401(k) dollars between pre-tax and Roth — In 2006, your total 401(k) contributions from all sources are limited to $15,000 (or $20,000 if you’re 50 or older). You could choose to put all $15,000 into either the pre-tax portion of your 401(k) or the Roth (after-tax) portion. However, you also could divide the $15,000 between the two portions, in any ratio you choose. For example, you could defer $7,500 of your pre-tax earnings into the “regular” portion and $7,500 of after-tax earnings into the Roth portion.

Before investing in the new Roth feature of your 401(k), you may want to consult with your tax adviser and investment professional. You might only have a few years during which to take advantage of the Roth 401(k), because it will cease to be offered in 2010, unless Congress makes it a permanent feature of the retirement planning landscape.

As long as it’s around, the Roth 401(k) is going to be a valuable retirement savings vehicle. If it’s available in your plan, I advise you to give it a serious look. Feel free to call if you have questions, and Happy New Year!

Eric Cumley is a Certified Financial Planner and investment representative with Edward Jones in south Everett. He can be reached at 425-353-2322. Edward Jones is an NYSE-member investment firm with more than 9,000 offices nationwide.

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