The New Roth Choice

Beginning in 2006, 401(k) retirement plans and 403(b) tax-deferred annuity plans may permit participants to make after-tax Roth contributions, modeled on the popular Roth IRAs. Earnings on Roth contributions to a 401(k) or 403(b) plan grow tax-free, and qualified distributions from Roth plan accounts, including the earnings, are not subject to income tax. Only distributions that satisfy certain timing and retention requirements are qualified.

Roth contributions to a plan count as pre-tax elective deferrals for annual limitations ($15,000 for 2006) and, in a 401(k) plan, must be included in the annual ADP nondiscrimination test. However, Roth contributions do not count as after-tax contributions for purposes of the annual ACP nondiscrimination test.

Although Roth plan accounts have the same tax treatment as Roth IRAs, individuals are eligible to make Roth contributions to a plan even if they do not satisfy the income limits applicable to Roth IRAs. In other words, if a single individual makes over $110,000 (or a married, joint filer makes over $160,000) in 2006, that individual may not make contributions to a Roth IRA, but may make Roth contributions to a 401(k) or 403(b) plan that permits such contributions.

Roth IRAs are popular, and 401(k) and 403(b) plan participants may be eager to see their plans amended to permit Roth contributions. But there is a downside for plan sponsors and administrators. Because Roth accounts have different tax treatment than accounts funded by elective pre-tax contribution or traditional after-tax contributions, plans with Roth accounts will be more complex to administer. A plan sponsor may decide to amend a plan to allow Roth contributions, but should do so only after weighing carefully the advantages and disadvantages.