By Andrew R. Lee, Esq.  and
                          Robert B. Johnston, Esq.

Effective January 1, 2006, 401(k) plans and 403(b) plans have the ability to add a "Roth" feature, similar to that of the "Roth IRA". Just like with Roth IRAs, funds contributed to the Roth 401(k) or 403(b) would be made from after tax dollars, rather than pre-tax dollars. Also, like Roth IRAs, withdrawals from these new 401(k) and 403(b) plans will generally be tax-free.

Contribution Limits

For 2006, the contribution limit for these new accounts will be $15,000. However, if the employee is over the age of 50, then the contribution limit will be $20,000.

No Income Phase Out

Unlike Roth IRAs, which are not available to single individuals whose adjusted gross income is over $110,000 per year, or a married individuals with adjusted gross income over $160,000 per year, there is no income threshold for participation in a Roth 401(k) or 403(b).

Conversion of Traditional Accounts into Roth Accounts

There is currently no provision to allow for the conversion of a traditional 401(k) or 403(b) into a Roth type account. Therefore an employee cannot elect to move the funds which are currently in his or her traditional account, into a new Roth account. Rather, the funding of these new Roth accounts would commence with new contributions starting in January 2006.

Participation in a Roth and Non-Roth Plan

If the employer adds the Roth option as part of its 401(k) or 403(b) plan, the employee may choose to characterize some or all of his or her annual contribution as Roth contributions. However, the 2006 $15,000 (or $20,000) contribution limit would apply to Roth and non-Roth accounts in the aggregate. Furthermore, from the employer’s perspective, if both traditional and Roth plans are to be offered to employees, the employer would need to keep separate accounts for the traditional and Roth contributions.

Timing of Withdrawals

Similar to Roth IRAs, there is a five year waiting period before distributions can be taken from the plan. However, unlike the Roth IRAs, under the current rules for Roth 401(k)’s and 403(b)’s, Required Minimum Distributions do have to be withdrawn upon the employee reaching the age of 70.5, or (except for 5% owners) upon retirement, if later. This is different than the rules for Roth IRAs, which are not subject to the 70.5 Required Minimum Distribution rules.

If You Are an Employer, Should You Add the Roth Feature to your Plan?

As an Employer, you might consider offering the Roth feature to your employees. In order to add this feature, your current plan will need to be amended. Many employees will perceive the choice between after-tax Roth accounts that will normally be distributed tax free as a valuable planning alternative to traditional 401(k) and 403(b) accounts which are fully taxable when distributed. An Employer should weigh this benefit against the increased administrative and recordkeeping costs that it will incur before deciding whether to add a Roth feature to a qualified plan. In addition, Roth contributions will be subject to the same discrimination testing that applies to 401(k) deferrals and 403(b) deferrals. If your plan fails these tests in any year, participants must have the choice to receive a corrective distribution of either Roth or traditional 401(k) deferrals made in that year.

If You Are an Employee, Should You Elect to Contribute After Tax Dollars to the Roth?

Bymaking after tax dollar contributions to the Roth, you would be giving up the income tax deferral that you would ordinarily receive by contributing funds to a traditional 401(k) or 403(b) account. However, what you would gain is the ability to withdraw funds from the Roth account, including earnings on your contributinscontributions, on a tax-free basis. In order to make an informed decision about whether to contribute to the Roth or a traditional plan, it will be important toconsider factors such as (i) how many years will it be until you will need access to the retirement funds; (ii) whether you anticipate being in a lower tax bracket when you are required to start taking distributions (i.e., at age 70.5, or retirement if later); and (iii) how the loss of the current tax deduction will impact you.

Howard & Howard’s Guidance

If you are an employer, Howard & Howard Attorneys, P.C. can assist you with evaluating the costs and benefits of adding a Roth feature to your current 401(k) or 403(b) plan. If you choose to implement such an addition to your current plan, then we can assist you with the amendment of your current plan in order to add this feature. If you do not currently have a plan, then we can help you design a plan to meet the goals and objectives of your company. In addition, we are available to meet with your employees or prepare documentation for them, explaining the new retirement features and their various contribution options.

If you are an employee, Howard & Howard Attorney’s P.C. can assist you with the analysis of whether you should elect to contribute some or all of your retirement contributions to a Roth account.

Our counseling and analysis for either employers or employees can be done as part of a team with your other advisors such as accountants, brokers, bankers, insurance agents, and other financial advisors, or on an individual basis.

If you would like to learn more about the new Roth 401(k)’s and 403(b)’s or if you have any other questions relating to retirement planning, Howard & Howard’s Employee Benefits and Estate Planning Attorneys would be happy to assist you.

For more information, please contact any of the following Employee Benefits and Estate Planning Attorneys: