The Roth 401(k) is Coming

While I’m surprised we have not heard more about them, I suspect that as 2005 comes to a close individuals will hear a lot more about the Roth 401(k) plan, set to be instated in 2006. The Roth IRA has truly been a boon for investors, allowing them to contribute as much as $4,000 per year in after-tax dollars to an account where profits are tax-free at age 59 1/2. Investment principal can even be withdrawn early tax-free with no penalty.

As great as this deal is for investors, the Roth IRA’s glaring limitations (namely annual contribution limits and income limits that don’t allow the wealthy to participate) do provide some discontent. However, beginning in 2006 employers will have the option of offering their workers a Roth 401(k) plan, which can take the place of an employee’s traditional 401(k) retirement account.

The Roth 401(k) will have similar contribution limits to a regular 401(k), $15,000 per year in 2006, which far surpasses the Roth IRA limits. As with regular 401(k) plans, there will not be income limits with the new plan. Contributions will be treated just like a Roth IRA, meaning after-tax dollars are used (as opposed to the current plan that uses pre-tax dollars) and withdrawals after age 59 1/2 are tax-free.

For those with extra income who are looking to invest for their retirement in a tax-efficient way, the Roth 401(k) could be the single best way to accomplish that feat starting next year. That assumes of course that your employer will choose to offer it as an option, as it will be strictly a voluntary offering.