Effectively Using The Roth 401(k)

Effectively Using The Roth 401(k)

If you’re accumulating wealth from your own business, the Roth 401(k) should have your attention. Making contributions to a traditional Roth IRA is not available to high-income earners. In 2013, individuals with modified adjusted gross income (MAGI) of $127,000 or more or couples (filing joint tax-returns) with MAGI of $188,000 or more cannot contribute to a Roth IRA. The Roth 401(k), however, is available to anyone whose company offers it and it can potentially grow some of your assets — tax-free.

In 2013, 401(k) plan participants can contribute up to $17,500 per year, or $23,000 if you are at least 50 years old. The largest difference between a Roth 401(k) and traditional 401(k) is the tax treatment of contributions and distributions. Contributions to a traditional 401(k) are tax-deductible, while contributions to a Roth 401(k) are not. In addition, any Roth 401(k) earnings can be withdrawn tax-free at the federal and state level if taken as part of a qualified distribution. On the other hand, all traditional 401(k) withdrawals will be taxed as ordinary income and may be subject to a 10 percent additional federal tax if withdrawn before age 59 ½.

There is another less obvious benefit to the Roth 401(k). Beginning at age 70 ½, you must take out required minimum distributions annually from retirement accounts, but not from Roth IRAs. If you are at least 70 ½ and have money in a Roth 401(k), you will generally be obliged to take minimum required distributions from that account. However, you could roll those Roth 401(k) assets into a Roth IRA. A direct rollover is non-taxable and there is no minimum distribution requirement from a Roth IRA for the original account owner. Now, your Roth 401(k) funds can continue to potentially grow tax-free for your or your heirs’ use.

David Menashe is a Senior Vice President and Wealth Management Advisor, and Bruce Morley is a First Vice President and Wealth Management Advisor, for Merrill Lynch, Pierce, Fenner & Smith Incorporated. (858.381.8113)

Photo by Andy Templeton