The Roth 401(k)
A. Roth 401(k) contributions were introduced by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). The Act allows, but doesn’t require, an employer to add a Roth contribution option to its 401(k) Plan starting January 1, 2006.
A. The basic difference between a Roth 401(k) and a traditional 401(k) is that the Roth version is funded with after-tax contributions while the traditional 401(k) is funded with pre-tax contributions. In other words, with a Roth 401(k) you pay taxes on the contributions but qualified distributions* are not subject to federal income tax. A traditional 401(k) saves you taxes today, but distributions are taxed.
* A distribution is qualified if the account is at least five years old, and the participant is at least age 59 1/2 or disabled or the distribution is on account of the participant’s death.
A. Anyone who meets plan eligibility requirements can elect to make Roth contributions.
A. Yes, individuals may maintain both types of accounts. The annual elective deferral limit ($18,000 in 2017) will apply to the total of traditional 401(k) and Roth contributions. In other words, you can’t save $18,000 in a traditional 401(k) and an additional $18,000 in a Roth 401(k). Participants need to understand that the Roth 401(k) is not an additional opportunity to save. It is simply an alternative savings opportunity with a different kind of tax treatment.
A. Yes, participants can receive an employer match on their Roth contributions. Employer matching contributions are made on a pre-tax basis. This requires participants to have both a Roth 401(k) account (for their personal contributions) and a traditional pre-tax account (for the employer matching contributions). The employer matching funds will grow on a tax-deferred basis and will be taxed as ordinary income at the time of withdrawal.
A. At retirement or employment termination, Roth 401(k) funds can be rolled into a Roth IRA or another Roth 401(k). They cannot be rolled into a traditional 401(k) or IRA.
A. Yes, subject to a few IRS rules.
A. How popular the Roth 401(k) will be is unclear. Many plan sponsors have indicated that they will be more likely to start offering a Roth 401(k) if their employees strongly indicate they intend to participate. Many industry analysts expect interest in the Roth contribution type from companies whose employees are in higher-income brackets, such as financial services, healthcare and professional services industries.
Some companies haven’t focused on making it available because they will need additional payroll accounting and systems ability to track Roth 401(k)s, potentially a significant expense. They will also need to develop educational campaigns to bring employees up to speed. That said, some companies will likely feel compelled to offer a Roth 401(k) to keep their benefits competitive.
A. 1. Adding a Roth after-tax contribution will add some complexity to the payroll and deferral-transmittal process. Payroll vendors and staff members involved in the payroll process will need to change their existing practices and systems in order to track and submit a new type of contribution, as well as accommodate different tax status of participant accounts.
2. 401(k) plan record keepers have enhanced their systems to track Roth contributions and earnings separately and differently from regular 401(k) deferrals. Distributions will also become more complex as participants may have two deferral sources from which to take a loan or distribution.
3. The Roth provisions will need to be reflected in the plan document and explained in the Summary Plan Description. This will require a plan amendment for any plan electing to offer the Roth 401(k).
A. Roth 401(k)s are similar to Roth IRAs in this regard: an investor must hold the account for five years before a tax-free withdrawal. In other respects, a Roth 401(k) will be similar to a traditional 401(k); withdrawal before age 59½ may be available, but a 10% penalty will apply to the taxable amount. Roth 401(k) assets are available for withdrawal under the same circumstances as traditional 401(k) assets.
There are a number of outstanding related issues which we expect the IRS to clarify. There are questions about required minimum distributions (RMDs), loans, hardship withdrawals, corrective distributions resulting from failed non-discrimination tests and cash-out distributions.
A. Roth contributions are included in the ADP tests. A return of excess contributions due to a failed ADP test will be allowed.