Qualified Roth Contribution Program
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) contained a new code section, IRC Sec 402A, which allows an employer to add a “qualified Roth contribution program” to regular 401(k) or 403(b) qualified retirement plan.1
Qualified Roth Contribution Program
Under a regular 401(k) or 403(b) plan, a participant chooses to defer a portion of his or her compensation into the retirement plan. Such “elective deferrals: are made on a pre-tax basis, any account growth is tax-deferred, and withdrawals are taxed as ordinary income.
In a qualified Roth contribution program, a participant can choose to have all or part of his elective deferrals made to a sparate, designated Roth account. Such “designated Roth contributions: are made on an after-tax basis. Growth in the designated Roth account is tax-deferred and qualified distributions are excluded from gross income.
Other points:
- IRC Sec. 402A was effective January 1, 2006 and is subject to the “sunset” provisions of EGTRRA; unless the law is changed, no further contributions to a designated Roth account will be allowed after 2010.
- Separate accounting and recordkeeping are required for the deferrals under the 401(k) or 403(b) portions of the plan and for those made to the designated Roth account. Assets may not be transferred between a regular 401(k) or 403(b) plan and a designated Roth account.
- Individuals whose adjusted gross income exceeds certain limits may not contribute to a regular Roth IRA. There are non income limits applicable to a designated Roth account.
- For 401(k) plans, contributions to a designated Roth account are elective deferrals for purposes of the Actual Deferral Percentage (ADP) test.
Contributions
A number of rules apply to contributions to a qualified Roth contribution program:
- Dollar limitation:
- For 2006, a maximum of $15,000 may be contributed. Those who are age 50 and older may make additional contributions of $5,000. A participant may choose to place all of his or her contributions in the regular 401(k) or 403(b) portion of the plan, all in the designated Roth account, or split the deferrals between the two.
- Employer contributions:
- Employer contributions will be credited to the regular 401(k0 or 403(b) portion of the plan; they may not be designated as Roth contributions.
- Excess contributions:
- Excess deferrals to a qualified Roth contribution program must be distributed to the participant no later than April 15 of the year following the year in which the excess deferral was made. Otherwise, the excess deferral will be taxed twice, once in the year of the deferral and a second time the year a corrective distribution is made.
Distributions
A distribution from a designated Roth account will be excluded from income if it is made at least five years after a contribution to such an account was first made and at least one of the following applies:
- The participant reaches age 591/2
- The participant dies;
- The participation becomes disabled.
Other points:
- First-time homebuyer expenses:
- In a regular Roth IRA, a qualified distribution may be made to pay for firs-time homebuyer expenses. This provision does not apply to distributions from a designated Roth account.
- Rollovers:
- A distribution from a designated Roth account may be rolled over into either a Roth IRA or another designated Roth account.
- Required minimum distributions:
- Generally, amounts in a designated Roth account are subject to the required minimum distribution rules applicable to plan participants when they reach age 701/2. However, a participant can avoid the mandated distributions by rolling over amounts in the designated Roth account into a regular Roth IRA.
Which Account To Choose?
The decision as to which typ of account should be used will generally be made on factors such as the length of time until retirement (or until fth funds are needed), the amount of money available to contribute each year, the participant’s current tax situation, and the anticipated marginal tax rate in retirement. A primary goal is the lowest lifetime tax burden.
- Regular 401(k) or 403(b):
- Generally, individuals with a relatively short period of time until retirement, or who expect that their marginal tax rate will be lower in terirement, will benefit more from the regular 401(k) or 403(b) plan.
- Designated Roth account:
- Younger individuals with more years until retirement and those who anticipate that their marginal tax rate will rise in retirement will generally benefit more from a designated Roth account. The fact that contributions to a designated Roth account are after-tax may cause cash-flow problems for some individuals. Higher income participants may find that taxable income will be higher with a designated Toth than with a regular 401(k) or 403(b) plan, potentially reducing tax breaks such as the child tax credit or AMT exemption.
- Both:
- Some individuals may choose to contribute to both types of plan, to provide flexibility in retirement.
Securities offered through
Ogilvie Security Advisors, Corp.
900 N. Michigan Avenue Suite 1860, Chicago, IL 60611
(312) 335-5476
Member NASD/SIPC