8 Things You Need To Know About a Roth 401K for 2008

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The vast majority of Americans still make their salary reduction contributions to traditional 401K’s. This is mainly due to the fact that you weren’t even allowed to make a Roth contribution into a 401K until 2006.

If you participated in a 401K plan, prior to 2006, your only choice was to make a traditional pre-tax contribution to a 401K. Sadly, it still is the only choice for the vast majority of Americans.

Many employers have been slow to amend existing 401K plans that would give employees the choice of making a Roth contribution; a lot of employers don’t want to deal with the extra work and administrative responsibilities that come with making the changes to an existing 401K plan. So, they put it on the back burner, at the end of the TO DO LIST, which is what’s happened over the past 2 years.

For my money, if your employer is one of the few offering a Roth 401K contribution alternative, it’s a good sign for you as an employee. It tells me the employer is proactive and cares about the future(s) of those that work there.

8 Things you need to know about a 401K Roth designated contribution for 2008:

Roth contributions to a 401K are after tax contributions that do not affect current taxable income reported.

The maximum employee annual contribution for 2008 is $15,500. For employees aged 50 or older, the law now permits a “catch up” contribution of an additional $5,000 in 2008.

When you sign up to make Roth designated 401K contributions (much like a regular 401k) your contribution is usually automatically taken out of your salary.

If you participate in a Roth 401K plan and your employer matches a portion of your contribution, the employer’s contributions will be made into a regular 401K. Essentially you will have both a Roth 401K account and a traditional 401K account.

There are no income restrictions (as there are with a Roth IRA) that limit your ability to make a Roth 401K contribution. Regardless of how much money you make - you are entitled to make a max annual contribution of $15,500 for 2008, just like anyone else.

For high income earners, this makes your ability to have a Roth 401K doubly appealing. IMHO, it would make sense for those ineligible to make a Roth IRA contribution to look seriously at making Roth 401K contributions.

The maximum elective deferral (fancy way of saying ‘contribution’) you can make for 2008 is $15,500 (as you know), but your employer can make an additional contribution on your behalf. Annual contributions to all of your accounts (including your elective deferral) can not exceed the lesser of 100% of your salary or $46,000 for 2008.

For example, let’s say William Firmatus is a business owner that earns $120,000 in 2008. He has no employees and sets up a Roth 401K for himself. William makes the maximum employee deferral of $15,500. The business is entitled to make an additional contribution of $30,500 on behalf of William for 2008.

This will bring William’s total for 2008 up to the maximum of $46,000. $15,500 of which is contributed to his Roth 401K, $30,500 of which is contributed to his traditional 401K.

You can take a loan from your Roth 401K, much the same as you can from a regular 401K.

If you don’t roll over your Roth 401K (into a Roth IRA) before you reach age 70 1/2 you will be forced to take a RMD (required minimum distribution), much the same way you have to in a regular IRA or regular 401K.

It’s good to be aware of this fact, although it’s highly unlikely you will still be holding your Roth 401K with your employer when it comes time to take your RMD.

For those of you that participate in 403(b) plans, all the rules regarding Roth contributions (above) are more or less the same as those for 401K plans.

• This post was featured in the 141st edition of the carnival of personal finance held at Broke Grad Student.

Tags: Roth 401K