Boost for Roth 401(k)s

Roth 401(k)s haven’t caught on in a big way yet. But the new small business law gives this retirement plan innovation a boost. It allows you to roll over a pre-taxed account balance to a designated Roth 401(k) account. What’s more, you can elect to split the taxable income for a 2010 rollover over the next two years.

The same basic options are available to employees who participate in 403(b) plans with a Roth feature.

The Roth 401(k) was created in 2001 by the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), but this feature didn’t actually become available until Jan. 1, 2006. It was originally scheduled to “sunset” after 2010 along with other EGTRRA provisions, but it was extended by the Pension Protection Act of 2006 (PPA).

As with a regular 401(k) plan, contributions to a Roth 401(k) plan grow on a tax-deferred basis. However, unlike a regular 401(k), elective deferrals aren’t made with pre-tax dollars. The amounts contributed to the plan are subject to current tax.  Instead, with a Roth 401(k) plan, qualified distributions from the plan are completely tax-free. In comparison, distributions from a regular 401(k) plan are taxable at ordinary income rates.

Under the new small business law, 401(k) participants can roll over pre-tax balances to a Roth account, starting Sept. 27, 2010. This is generally the balance in a 401(k) account with elective deferrals, matching contributions and earnings. The rollover is taxable except to the extent it represents any after-tax contributions.

However, if the rollover occurs in 2010, you can split the taxable income between 2011 and 2012. Thus, the new rules mirror the rules for regular IRA-to-Roth conversions in 2010.

As with a regular conversion, you must take many factors into account, including your expected tax rate in the future. We can provide guidance with respect to this decision. Call us at 562-868-6333 to schedule a meeting to discuss your particular situation.

Very truly yours,

Emil Estafanous, CPA

P.S.  The Roth 401(k) is a viable option, but it is not for everyone. Our expert staff can assist you if you call us at 562-868-6333.

About Emil Estafanous, CPA
Certified Public Accountant (CPA) Tax Professional committed in representing taxpayers and resolving their tax problems.

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