Beginning in 2006, employer-provided 401(k) salary reduction plans have new flexibility. Assuming the employer chooses to amend the plan to offer the new choice, an employee will have the ability to designate the salary reduction amount as a non-deductible Roth account rather than a traditional deductible account. While funds going into Roth status are non-deductible, the eventual retirement withdrawals are tax free.

This new option has significance for several reasons. First, any employee with access to a 401(k) or a 403(b) tax-sheltered annuity can now access a Roth investment (assuming the employer has completed the paperwork that allows access). The Roth 401(k) option is not income-restricted. In the past, middle and upper income filers have not been permitted to invest in Roth IRAs, but the Roth 401(k) has no such limit.

A second distinction is that the Roth 401(k) allows a substantial investment by comparison to the Roth IRA. The 2006 limit for a Roth IRA is $4,000 ($5,000 if age 50 or over), whereas a Roth 401(k) allows $15,000 annually ($20,000 if age 50 or over).

Upon retirement, Roth 401(k) participants will typically roll their account into a Roth IRA. The Roth IRA account is exempt from any mandatory distribution rules. The retiree (or surviving spouse) can access the funds tax-free at any time, or continue the accumulation. Any undrawn funds are passed to heirs who also extract the amounts tax free.

So is the Roth 401(k), if available, the right choice for you? For those nearing retirement in upper tax brackets, the traditional approach of deducting 401(k) investments today and paying tax during retirement may be preferable. However, for those who can maintain the Roth funds for many years, or for those motivated to create significant tax-free funds that can be passed to children, the Roth 401(k) will be of interest. Please let us know if we can assist in this decision.