Roth 401(k), 403(b): Which Is Right For You?

By Denise Appleby AAA

Many taxpayers find the Roth IRA attractive, because of its tax free feature, and the fact that required minimum distributions (RMD) do not apply while the owner is alive. In addition, there is no maximum age for making contributions, unlike traditional IRA contributions which are subject to an age limit. The Roth 401(k) is also becoming increasing popular because of its tax-free feature. In this article, we highlight a few of the major features of these accounts and some of the factors that you may consider when deciding whether to choose a Roth instead of a traditional retirement savings vehicle.

Tutorial: Retirement Planning

Income Limitation for Roth Conversions Eliminated in 2010 under TIPRA
Effective 2010 and beyond, Tax Increase Prevention and Reconciliation Act (TIPRA) eliminated the $100,000 modified adjusted gross income (MAGI) cap for individuals looking to convert their non-Roth IRAs and other eligible retirement accounts to Roth IRAs. It also eliminated the requirement that married couples file a joint tax return to be eligible for a Roth IRA conversion. This allows more individuals to enjoy the benefits that Roth IRAs provide. As an added incentive to convert retirement accounts to Roth accounts in 2010, TIPRA also included an optional provision that allowed income from any Roth conversion done in 2010 to be included in income ratably over 2011 and 2012, instead of being paid when taxes for 2010 was due. (To find out more, see TIPRA Helps Convert Your Plans And Save More, Recent Legislative And Other Updates and Tax-Saving Advice For IRA Holders.)

The Roth 401(k) , 403(b) or 457(b)
The second option for funding a Roth is the "designated Roth contribution program" (DRA). Under this program, participants may designate salary deferral contributions to 401(k) ,403(b)  and governmental 457(b) plans as Roth contributions.

With a Traditional 401(k) , 403(b) or 457(b) plan, salary deferral contributions are generally used to reduce the participant's taxable income (i.e. contributed on a pretax basis) from salary, and are taxed when withdrawn. With a DRA program, the contributions are made on an after-tax basis, but the money invested in the account grows tax-deferred, and distributions are tax-free - provided the distribution occurs after a five-taxable-year period and the participant is at least 59.5, disabled or deceased when the distribution occurs.

If your employer provides you with the opportunity to contribute to a Roth 401(k) ,403(b) and/or 457(b) account, the following are some factors that are usually considered to favor the Roth option over the traditional :

  • You have quite a few years to save for retirement and plan to keep the money invested for a long time.
  • You are in a low tax bracket today, or feel that your tax bracket will be higher when you retire.
  • You want your heirs to keep as much of the money they inherit from you as possible.
  • You don't rely on the tax savings realized on your current contributions to your Traditional account to meet your household budget.

Of course, your financial professional should be consulted to ensure that you are making the right choice, as there are other factors that may make a Traditional IRA or 401(k) plan more favorable for you. (To find out more about 401(k) and 403(b) plans, read A Closer Look At The Roth 401(k), Introducing The Roth 401(k) and Introductory Tour Through Retirement Plans.)

For 2013 you can generally contribute up to $17,500 to a 401(k) and/or 403(b) account  and a governmental 457(b) through salary deferrals. If you are at least age 50 by year-end, you are eligible to contribute an additional amount of up to $5,500 as a catch-up contribution. Employers may limit the amount you can contribute to a percentage of your salary, which could result in lower contribution amounts. For instance, the plan may be designed to limit contributions to 10% of compensation, which would limit contributions (minus catch-cup amounts) to $5,000 for someone whose compensation is $50,000. Even if you cannot afford to contribute the maximum amount, try to contribute enough to receive the maximum amount of any matching contributions your employer may make to the plan. If your plan does include a matching contribution feature, bear in mind that matching contributions will be made to a traditional pretax account.

Do Roths Make Sense For You?
Does it make sense to forgo tax savings today in anticipation of the tax-free growth provided by Roth accounts? You'll only know for sure when the time comes for you to withdraw money from these accounts, at which point you will see whether tax rates have risen over the years and whether Roth distributions have remained completely tax-free as promised back in 1997. As mentioned earlier, there are other non-tax related factors to consider. A competent financial planner can help you make realistic projections and educated decisions.

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