Do You Have Time to Take Advantage of the New Roth 401k?

As of January 2006, many investors have a new retirement savings option: the Roth 401k. And it could potentially be a big boon to those individuals who are approaching retirement and want to save more.

First off, the Roth 401(k) isn’t for all seniors. If you’re in retirement, it isn’t available to you, because a s with the traditional 401(k), the Roth 401(k) is offered by employers. But for individuals who are still working, the Roth 401(k) may be a viable investment option.

Just as it sounds, the Roth 401(k) combines features of the Roth Individual Retirement Account (IRA) and the traditional 401(k). As with a Roth IRA, contributions to a Roth 401(k) are made on an after-tax basis; the account grows tax-free; and withdrawals are not subject to income tax (provided you’ve held the account for five years or more, and the distribution is made after you reach age 59½, if you become disabled, or if you die). But as with a 401(k), you may contribute to a Roth 401(k) regardless of your income, and its contribution limits are the same as the traditional 401(k), which in 2006 is $15,000—or $20,000 for those 50 or older.

What that means: If you’re trying to stash as much as possible into your retirement accounts, the Roth 401(k) could potentially be a good opportunity, depending on your other financial circumstances.

Before you call your employer, though, you may want to be aware of two things. First, the contribution limit applies to contributions to both types of 401(k) plans, so you can only save a total of $20,000 in your traditional 401(k) and Roth 401(k) combined. However, you can use both plans, contributing, for example, $10,000 to each. Second, the Roth 401(k) is a provision of the Economic Growth and Tax Relief Reconciliation Act of 2001, which expires in 2010 unless renewed. If it expires, it’s uncertain what will happen with Roth 401(k) accounts.

So who might choose the Roth 401(k) over the traditional 401(k)? That’s a personal decision which you should discuss with someone familiar with your individual financial circumstances and goals, such as your financial or tax advisor. But in general, if you expect your tax rate to be the same or higher in retirement than it is now, you might choose a Roth 401(k). Or, if you think your tax bracket will be lower in retirement than it is now, you might choose a traditional 401(k).