ROTH 401k PLANS

<body topmargin=0 leftmargin=0 marginheight=0 marginwidth=0> <table cellpadding=0 cellspacing=0 border=0><tr> <td valign="top" colspan=2 height=90 BGCOLOR="#006699" TEXT="#080000" bgproperties="fixed" background="07a285a1erlcgo.gif"> <div> <FONT SIZE="5" COLOR="#FFCC66" FACE="Arial" ><B>401 (k) PLANS</B></FONT><B>     |     </B><A HREF="index.htm" TARGET="_top" TITLE="401 (k) PLANS"><U><B>home</B></U></A></div> <div> <A HREF="id24.htm" TARGET="_top" TITLE="OVERVIEW OF 401k PLANS"><U>OVERVIEW OF 401k PLANS</U></A>   |   <A HREF="id20.htm" TARGET="_top" TITLE="401k CONTRIBUTIONS"><U>401k CONTRIBUTIONS</U></A>   |   <A HREF="id58.htm" TARGET="_top" TITLE="VESTING"><U>VESTING</U></A>   |   <A HREF="id21.htm" TARGET="_top" TITLE="NONDISCRIMINATION RULES"><U>NON-DISCRIMINATION RULES</U></A>   |   <A HREF="id22.htm" TARGET="_top" TITLE="401k DISTRIBUTIONS"><U>401k DISTRIBUTIONS</U></A>   |   <A HREF="id23.htm" TARGET="_top" TITLE="SIMPLE 401k PLANS"><U>SIMPLE 401k PLANS</U></A>   |   <A HREF="id54.htm" TARGET="_top" TITLE="SOLO 401ks"><U>SOLO 401ks</U></A>   |   <B>ROTH 401k PLANS</B>   |   <A HREF="id30.htm" TARGET="_top" TITLE="REVIEW QUESTIONS "><U>REVIEW QUESTIONS </U></A>   |   <A HREF="id46.htm" TARGET="_top" TITLE="FINAL EXAM"><U>FINAL EXAM</U></A>   |   <A HREF="id52.htm" TARGET="_top" TITLE="Printable Versions"><U>Printable Versions</U></A></div> <div> </div> </td> </tr><tr> <td valign="top" width=210 BGCOLOR="#FFCC66" TEXT="#080000" background="079d2c00dkelyh.gif"> <bR> <div> <A HREF="http://www.wallstreetinstructors.com" TARGET="_top" TITLE="http://www.wallstreetinstructors.com"><U><IMG SRC="080af630.gif" border=0 width="175" height="99" ALIGN="BOTTOM" HSPACE="0" VSPACE="0"></U></A></div> <div> <B>Copyright</B><FONT SIZE="2" COLOR="#006699" FACE="Arial" ><B>© </B></FONT><B>2001, 2003, 2007</B><FONT SIZE="2" COLOR="#006699" FACE="Arial" ><B> </B></FONT><B> Wall Street Instructors, Inc.  All rights reserved. </B></div> <bR> <bR> <div> <TABLE BORDER="5" CELLPADDING="2" CELLSPACING="1" WIDTH="170" BORDERCOLORLIGHT="#C0C0C0" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" ALIGN="BOTTOM" HSPACE="0" VSPACE="0" BGCOLOR=#FFFFFF > <tR> <tD VALIGN=TOP HEIGHT= 20 ><NOBR><div> <A HREF="mailto:instructor@wallstreetinstructors.com" TARGET="_top" TITLE="mailto:instructor@wallstreetinstructors."><U><B>E-Mail An Instructor</B></U></A></div> </NOBR></tD> </tR> </TABLE></div> <bR> <div> <TABLE BORDER="5" CELLPADDING="2" CELLSPACING="1" WIDTH="145" BORDERCOLORLIGHT="#C0C0C0" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" ALIGN="BOTTOM" HSPACE="0" VSPACE="0" BGCOLOR=#FFFFFF > <tR> <tD VALIGN=TOP HEIGHT= 40 ><NOBR><div> <A HREF="id57.htm" TARGET="_top" TITLE="Roth 401ks"><U><B>printable version</B></U></A></div> <div> <B>of Roth 401ks</B></div> </NOBR></tD> </tR> </TABLE></div> <bR> <div> <B>ROTH 401ks</B></div> <bR> <div> <A HREF="id55_m.htm#participation" TARGET="TRLX_Middle" TITLE="ROTH 401k PLANS"><U>Participation</U></A></div> <div> <A HREF="id55_m.htm#contributions" TARGET="TRLX_Middle" TITLE="ROTH 401k PLANS"><U>Contributions</U></A></div> <div> <A HREF="id55_m.htm#distributions" TARGET="TRLX_Middle" TITLE="ROTH 401k PLANS"><U>Distributions</U></A></div> <div> <A HREF="id55_m.htm#rollovers" TARGET="TRLX_Middle" TITLE="ROTH 401k PLANS"><U>Rollovers</U></A></div> <bR> </td> <td valign="top" height=390 BGCOLOR="#FFFFFF" TEXT="#080000"> <div> <I><B>ROTH 401k PLANS</B></I></div> <bR> <div> Tax reforms enacted in 2001 permitted the creation of Roth 401k beginning in tax year 2006.  These accounts are similar to Roth IRAs: after-tax dollars are contributed, the investment income grows in a tax-sheltered account, and withdrawals are taken tax-free (subject to restrictions).  While similar in concept to Roth IRAs, Roth 401ks differ in some respects -- these difference are noted for comparison purposes.</div> <bR> <div> Legislation in 2001 authorized Roth 401ks through 2010.  The Pension Protection Act of 2006 make Roth 401k plans permanent.  Now that the uncertainty surrounding the permanence of these accounts is gone, it is likely that Roth 401ks will be incorporated into more company plans.  Technically, Roth 401k plans are not separate, stand-alone cash or deferred arrangements, but rather a way of accounting for after-tax contributions into 401k plans.   </div> <bR> <bR> <div> <B> <A NAME="participation"><IMG BORDER="0" SRC="1x1.gif" HEIGHT="1" ALIGN="bottom" WIDTH="1" HSPACE="0" VSPACE="0" ></A></B><B>Participation</B></div> <bR> <div> Although the tax code permits Roth 401k plans, it does not require employers to offer them to their employees.  Each employer must decide whether to offer Roth accounts — and if an employer offers such accounts to one or more of its employees, it must offer them to all eligible employees. (Employers may opt to offer only a traditional 401k, but may not opt to offer solely a Roth 401k plan.  Employers that offer a Roth plan, must also offer a “traditional” plan.).    </div> <bR> <div> The list of employees eligible for Roth 401ks is the same as for any 401k plan — namely: 21 years of age or older, at least one year of service, and not covered by a collective bargaining agreement.  Unlike Roth IRAs, which are not available to taxpayers exceeding certain income thresholds, Roth 401k plans are available to all eligible employees regardless of their income.  </div> <bR> <bR> <div> <B> <A NAME="contributions"><IMG BORDER="0" SRC="1x1.gif" HEIGHT="1" ALIGN="bottom" WIDTH="1" HSPACE="0" VSPACE="0" ></A></B><B>Contributions</B></div> <bR> <div> The annual contribution limits discussed earlier apply to all 401ks. So, an employee’s elective contributions cannot exceed $15,500 plus catch-up amounts (in 2007), regardless of whether those contributions are directed to a “traditional” 401k or a Roth 401k plan.    The difference is whether the elective contribution will be taken from the employee’s before-tax or after-tax compensation.  In the case “before-tax” contributions to a “traditional” 401k plan, the employer deposits the employee’s elective contribution into the plan, and the employee excludes the contribution from his or her taxable income when filing the annual tax return.  In a Roth 401k, the employer withholds payroll taxes from the contribution before depositing it into the account, and the employee declares the amount contributed to the Roth 401k as taxable income on his or her tax return.  Once contributions are allocated to a Roth 401k they cannot be converted back into a “traditional” 401k. Employees may change whether future contributions will be treated as Roth or “traditional” — but there is no undoing previous 401k contributions. (Please note: this differs from Roth IRAs where some “recharacterization” of previous contributions is allowed.)   As with “traditional” 401ks, the employer may match an employee’s Roth 401k contributions, make non-elective contributions or allocate plan forfeitures to participating employees’ accounts.  </div> <bR> <div> Employees must be given a chance to change the status of their contributions at least once per year.   For plans that have an automatic enrollment provision, the employer must disclose to the employee whether the automatic contribution will be “pre-tax” (traditional) or “after-tax” (Roth),  and give the employee the opportunity to change the status of the contribution.   </div> <bR> <bR> <div> <B>Separate Account</B></div> <bR> <div> 401k plans with the Roth feature must set up a separate account (for each employee) to hold funds contributed on an after-tax basis plus the investment earnings on those contributions.  An employee’s elective contributions to a Roth 401k, and any earnings on those contributions, must be held separately from an employer’s matching and non-elective contributions, as those contributions are  made on a before-tax dollars.  So, a Roth 401k is really two accounts, one to hold after-tax elective contributions plus earnings on those contributions, and one to hold all of the other “pre-tax” contributions plus earnings on pre-tax funds.  Keep in mind, employees may choose to make a Roth contribution in one year and a traditional contribution the next.  Traditional elective contributions, as well as employer contributions, will be allocated to the “pre-tax” separate account.   This separate accounting requirement increases the administrative cost to employers, and may lead some to choose not to offer a Roth 401k.</div> <bR> <bR> <div> <B> <A NAME="distributions"><IMG BORDER="0" SRC="1x1.gif" HEIGHT="1" ALIGN="bottom" WIDTH="1" HSPACE="0" VSPACE="0" ></A></B><B>Distributions</B></div> <bR> <div> The primary advantage of a Roth 401k is that distributions are “tax-free”.  To qualify for the tax-free distribution, </div> <bR> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.gif" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">the account must be open for at least five consecutive tax-years, and </div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.gif" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">the employee is over age 59½, (or is disabled or dies). </div> <bR> <div> This is a much stricter list than for <A HREF="id22_premature_withdrawals.htm" TARGET="_top" TITLE="401k DISTRIBUTIONS"><U>“premature distributions” from a traditional 401k plan</U></A> — and serves different purpose: this list is used to determine the taxability of a Roth distribution, not whether the distribution is subject to a penalty.  If the participant meets these criteria, distributions from the Roth 401k are tax-free.    </div> <bR> <div> <B>Please note</B>: This list is also stricter than for Roth IRAs, which allow tax-free withdrawals for first-time homebuyers.</div> <bR> <div> The five-year holding period begins from the first day of the tax-year the employee contributes to the Roth account. </div> <bR> <bR> <div> <TABLE BORDER="2" CELLPADDING="10" CELLSPACING="1" WIDTH="483" BORDERCOLORLIGHT="#FFCC66" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" ALIGN="BOTTOM" HSPACE="0" VSPACE="0" BGCOLOR=#006699 > <tR> <tD VALIGN=TOP HEIGHT= 231 WIDTH="455"><div> <B>Example: Margo Healey, age 56, makes a contribution to her Roth 401k on December 14, 2006. Her holding period begins on January 1, 2006 (first day of the tax year of the contribution).  The 5-year holding period will end on December 31, 2010 (assuming Margo is a calendar year taxpayer).  Distributions prior to December 31, 2010 will not qualify for tax-free status.</B></div> <bR> <div> <B>Assume Margo contributes $3,000 to her Roth IRA each of the next nine years.  In 2016, at age 65, Margo withdraws the entire amount from the Roth IRA. The account value is $59,000 ($27,000 of contributions plus $32,000 of accumulated earnings). She may take the distribution tax-free: she satisfies the 5-year holding period (since the first contribution) and she is over age 59½.</B></div> </tD> </tR> </TABLE></div> <bR> <bR> <div> Only distributions from the “Roth” account are tax-free (that is, distributions of after-tax elective contributions and investment earnings on those contributions). Distributions taken from the account holding pre-tax contributions, such as matching contributions, will be subject to tax when withdrawn — as with any traditional 401k withdrawal.  </div> <bR> <div> If a withdrawal is taken from a Roth 401k account prior to age 59½ (or death / disability) or before the 5-year holding period expires, the distribution is “non-qualified”, or in other words, taxable*. Keep in mind that the contributions to a Roth account were made in after-tax dollars, so only the earnings portion of a non-qualified withdrawal is taxable.  The taxable portion of the withdrawal is found by dividing the earnings in the Roth account by the total value of the Roth account.</div> <bR> <div> <TABLE BORDER="2" CELLPADDING="10" CELLSPACING="1" WIDTH="483" BORDERCOLORLIGHT="#FFCC66" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" ALIGN="BOTTOM" HSPACE="0" VSPACE="0" BGCOLOR=#006699 > <tR> <tD VALIGN=TOP HEIGHT= 125 WIDTH="455"><div> <B>Example: A 45-year participant takes a non-qualified distribution of $4,000 from his Roth 401k account.  The Roth account consists of $15,000 of Roth after-tax, elective contributions and $5,000 of tax-deferred earnings.  The taxable portion of the distribution is 25% ($5,000 earnings divided by the $20,000 value of the account).  So, 25% of the $4,000 distribution, or $1,000 is taxable income, the balance is tax-free return of principal.</B></div> </tD> </tR> </TABLE></div> <bR> <bR> <div> <B>Please note:</B> The tax treatment of non-qualified distributions from a Roth 401k differs from non-qualified Roth IRA distributions.  In the Roth 401k, a percentage of any nonqualified distribution is taxable.  In a Roth IRA, non-qualified distributions are treated on a FIFO (first-in, first-out) basis —  the first withdrawals are tax-free to the extent of any contributions, and then taxable earnings.  If the above example were a Roth IRA, the first $15,000 withdrawn would be tax-free, the last $5,000 would be taxable.   </div> <bR> <bR> <div> <B>Hardship Distributions  & Loans</B></div> <bR> <div> A 401k plan that includes a Roth feature may allow participants to withdraw funds due to “hardship”.  However, distributions from the Roth 401k account due to hardship do not receive any favorable tax treatment.  Unless the Roth account has been open for at least five tax-years and the employee is age 59½ (or dead or disabled), the distribution will be “non-qualified” and subject to partial taxation as discussed above.    </div> <bR> <div> If the employer’s plan permits loans from the 401k plan, a participant may borrow from the Roth 401k account — subject to the same limits as any 401k plan loans.  </div> <bR> <bR> <div> <B>Mandatory withdrawals</B></div> <bR> <div> As with all qualified plans, participants in a 401k plan face mandatory withdrawals beginning at age 70½.  This applies to “traditional” and Roth 401k plans.  <B>Please note:</B> holders of Roth IRAs are not required to take minimum mandatory distributions at age 70½.  This is another difference between Roth IRAs and Roth 401k plans.    Practically-speaking, participants in a Roth 401k plan can avoid the minimum mandatory distributions by rolling the Roth 401k plan assets into a Roth IRA when they reach age 70½ .  (This doesn’t eliminate all mandatory distributions: the 401k participant must still make mandatory minimum distributions from the 401k account holding  “pre-tax” contributions). </div> <bR> <bR> <div> <B> <A NAME="rollovers"><IMG BORDER="0" SRC="1x1.gif" HEIGHT="1" ALIGN="bottom" WIDTH="1" HSPACE="0" VSPACE="0" ></A></B><B>Rollovers</B></div> <bR> <div> Assets held in a Roth 401k plan may be rolled over into another employer’s Roth 401k plan (assuming the other employer allows Roth accounts) or into a Roth IRA.   There are two ways to move assets from one employer’s Roth 401k to another’s.  If the employee takes a distribution from the first employer’s Roth account, the only the tax-free portion of the distribution can be rolled over into the new employer’s Roth 401k — and this must be accomplished within 60 days of the distribution.  If, however,  the employee has the first plan’s custodian to transfer the assets directly to the new employer’s Roth plan, the entire amount of the assets (“tax-free’ and taxable) can be moved.   When rolling over to another employer’s plan, the start of the 5-year holding period of the first account carries over into the recipient plan (in other words, the “age” of the account is not disrupted).  </div> <bR> <div> If a plan participant rolls over Roth 401k assets to a Roth IRA, the holding period of the original Roth 401k plan is disregarded.  The holding period is based on when the Roth IRA was first established — which may or may not be an advantage to the participant.    </div> <bR> <div> <TABLE BORDER="2" CELLPADDING="10" CELLSPACING="1" WIDTH="483" BORDERCOLORLIGHT="#FFCC66" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" ALIGN="BOTTOM" HSPACE="0" VSPACE="0" BGCOLOR=#006699 > <tR> <tD VALIGN=TOP HEIGHT= 231 WIDTH="455"><div> <B>Example:  Layton, age 60,  has participated in a Roth 401k for two years, but has had a Roth IRA for more than five years.  Layton could rollover his Roth 401k funds to his Roth IRA and satisfy the 5-year test for all of his Roth assets -- and since he is over age 59½, he could take tax-free distributions immediately from the IRA.  </B></div> <bR> <div> <B>Assume instead, Layton has held a Roth 401k plan for several years but does not have a Roth IRA.  If he were to establish a Roth IRA to receive the rollover from the Roth 401k, he'd start a new 5-year waiting period before he could take qualified, tax-free distributions.</B></div> <bR> </tD> </tR> </TABLE></div> <bR> <bR> <div> A participant may rollover a Roth 401k to a Roth IRA through either a direct custodian-to-custodian transfer, or by accepting a distribution and rolling it into the Roth IRA within 60 days.  Under no circumstances may assets in a Roth IRA be rolled into a Roth 401k, even if the assets in the IRA originally came from a Roth 401k.   </div> <bR> <div> <B>One final note</B>:  Beginning in 2006, tax-sheltered annuities for public school teachers or employees of non-profit organizations (sometimes called TSAs, 403b plans or 501(c)3 plans) may also offer a Roth-style account.  These accounts are very similar in nature to Roth 401ks.  Assets in a Roth 401k can be rolled over into a Roth tax-sheltered annuity, or vice versa.  Assets in either of these can be rolled into a Roth IRA, but as explained above, a Roth IRA’s assets cannot be rolled into Roth 401k or Roth tax-sheltered annuities.  New IRS regulations are expected to make Roth 401ks and Roth 403bs even more similar in operation.   </div> <bR> <bR> <bR> <bR> <div> <A HREF="id64.htm" TARGET="_top" TITLE="Review 4"><U><B>to Study Review 4</B></U></A></div> <bR> <bR> <bR> <bR> <DIV ALIGN="LEFT"></DIV> <div> <TABLE BORDER="2" CELLPADDING="2" CELLSPACING="4" WIDTH="84" BORDERCOLORLIGHT="#C0C0C0" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" ALIGN="BOTTOM" HSPACE="0" VSPACE="0" BGCOLOR=#FFCC66 > <tR> <tD VALIGN=TOP HEIGHT= 20 WIDTH="66"><div> <A HREF="id30.htm" TARGET="_top" TITLE="REVIEW QUESTIONS "><U><B>NEXT</B></U></A></div> </tD> </tR> </TABLE></div> <bR> <bR> <div> <A HREF="id24.htm" TARGET="_top" TITLE="OVERVIEW OF 401k PLANS"><U><B>OVERVIEW OF 401k PLANS</B></U></A></div> <div> <A HREF="id20.htm" TARGET="_top" TITLE="401k CONTRIBUTIONS"><U><B>401k CONTRIBUTIONS</B></U></A></div> <div> <A HREF="id58.htm" TARGET="_top" TITLE="VESTING"><U><B>VESTING</B></U></A></div> <div> <A HREF="id21.htm" TARGET="_top" TITLE="NONDISCRIMINATION RULES"><U><B>NON-DISCRIMINATION RULES</B></U></A></div> <div> <A HREF="id22.htm" TARGET="_top" TITLE="401k DISTRIBUTIONS"><U><B>401k DISTRIBUTIONS</B></U></A></div> <div> <A HREF="id23.htm" TARGET="_top" TITLE="SIMPLE 401k PLANS"><U><B>SIMPLE 401k PLANS</B></U></A></div> <div> <A HREF="id54.htm" TARGET="_top" TITLE="SOLO 401ks"><U><B>SOLO 401ks</B></U></A></div> <div> <B>ROTH 401k PLANS</B></div> <div> <A HREF="id30.htm" TARGET="_top" TITLE="REVIEW QUESTIONS "><U><B>REVIEW QUESTIONS </B></U></A></div> <div> <A HREF="id46.htm" TARGET="_top" TITLE="FINAL EXAM"><U><B>FINAL EXAM</B></U></A></div> <div> <A HREF="id52.htm" TARGET="_top" TITLE="Printable Versions"><U><B>Printable Versions</B></U></A></div> </td> 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