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Current Pension Topics: Benefits of Roth 401(k) Plan Current Pension
Topics
As of March 2006, the City of New York is pleased to offer its employees a new kind of retirement plan: the Roth 401(k). As the name implies, the plan combines features of both the pre-tax 401(k) and the Roth IRA. All of these plans offer a tax-advantaged way to invest for retirement, but do so in different ways. The Roth 401(k) has a number of features that make it similar to the pre-tax 457/401(k). It is sponsored by an employer, not an individual. There are no income restrictions (high-income individuals cannot contribute to Roth IRAs). Additionally, the contribution limits are the same as for the pre-tax 401(k), which are much higher than with a Roth IRA. In 2006 you'll be able to put as much as $15,000 into all 401(k) plans combined. All of these types of plans (IRAs, 457s and 401(k)s) allow your investment to grow untaxed, but they differ in how the money is taxed when you put it in and take it out. The pre-tax 457/401(k) gives you a tax break now, but taxes funds when you withdraw them. The Roth 401(k), like the Roth IRA, gives you no tax break now, but you pay no taxes when you withdraw funds. There are some limitations you should be aware of: to withdraw from a Roth 401(k), you must be at least 59-1/2 years old and have had the account for at least 5 years; otherwise you may face a 10-percent penalty, as well as tax on the earnings. A Roth 401(k) can only be rolled over into another Roth 401(k) or Roth IRA. Finally, unless Congress votes to extend it, the legal provision that created the Roth 401(k) could expire in 2010. Your account would still exist, but you could no longer put more money into it. The chart below compares the pre-tax 457/401(k) with the after-tax Roth 401(k). We've broken the comparison into two columns: one, which puts money into a pre-tax plan; and one, which puts the same contribution amount into a Roth 401(k). There's a lot going on here, so we've broken key points of the explanation into small steps. Click the Next button to begin. The example used assumes that a one-time contribution of $5,000 was made at age 30, the tax rate is 20 percent throughout and there is a 7-percent annual growth rate.
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