The Retirement savings plan, Roth 401(k) introduced by the Economic Growth and Tax Relief Reconciliation Act, 2001 will come into force from January 2006. Unlike a traditional 401(k) Retirement Plan, a Roth 401k plan applies to all employees but the latter requires the contributions to the plan account with after-tax dollars while a 401k plan allows for contributions with pre-tax dollars.
As far as the employers’ contributions are concerned, these amounts will be matching the contributions of employees but with pre-tax dollars. The employer contribution will be rolled up in a separate account and funds withdrawn from that account will be subjected to taxes on withdrawal.
The Roth 401(k) plan may not allow you to get the benefit of the contribution from pre-tax dollars but it allows you to withdraw tax-free money after retirement. You can avoid paying income tax on the cash you withdraw from your plan account after retirement. But your age should be 59 and ½ years and you should have held the plan account for more than 5 years or more. In case you withdraw money before retirement, you will have to pay taxes (almost 35% of the contribution) and a 10% penalty.
A Roth 401(k) plan can be helpful as it prevents you from tax payments on withdrawal after retirement. But this will help you only if your tax bracket after retirement is same or higher than what it is now. If your current tax bracket is low, then you can contribute more towards the Roth 401(k) plan account. Your savings thus increase and you get to withdraw a higher amount at retirement. You can also roll over your Roth 401(k) balance into a Roth IRA whenever you leave your employment.
You can contribute a part of the allowed limit, which is $15,000 to a Roth 401(k) plan account and the rest to a 401(k) account, and thereby reduce the tax payments. This is because a Roth 401(k) allows you to contribute after-tax dollars whereas a 401(k) retirement plan account allows for pre-tax contributions.
With a Roth 401(k) plan contribution, you don’t take home several dollars since you are allowed to accumulate after-tax dollars into the plan account. But then you don’t have to pay taxes on the amounts taken out after retirement and this helps you especially if the tax bracket is higher at that time.
About the Author
Lance Williams is an established writer, working as a content developer for MortgageFit.com. He specializes in mortgage and real estate concepts.
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