MAY 2008 Pension Plan tip of the month...

ROTH 401(k) UPDATE

In January 2006, a new way to save for retirement was introduced for qualified plans.  This new contribution is called the Roth 401(k) Contribution. This new feature is only available to 401k plans with a salary deferral provision.

The attractiveness of Roth deferrals is that, although the contributions are made after-tax, the earnings are NOT taxable provided the distribution is “qualified”.

Distributions are “qualified” after 5 years of deposit and if the distribution requested is due to death, disability, or after the participant has reached age 59 ½.  The 5 year period begins on the first day of the participant’s taxable year (usually calendar year) during which the individual made his/her first designated Roth deferral. The period ends when 5 consecutive taxable years have been completed.  A participant does not need to make Roth contributions every year.

For example, if a participant makes his/her first Roth deferral on June 1, 2008, the participant’s first taxable year is 2008.  After the end of the 5th taxable year, December 31, 2012, the participant will have met the 5 year Roth participation requirement.

If your plan allows for in-service distributions at age 59 ½ and the Roth deferral account has been in existence for at least 5 years as explained above, contributions being distributed would not be taxable, (contributions were taxed when made), and the earnings would ALSO NOT be taxable.  In this situation, the 10% premature distribution penalty also would not apply.

As described above, a qualified distribution from the Roth deferral would not be subject to federal taxation. This makes the Roth 401(k) a unique tax planning tool as Roth earnings are tax-free rather than tax-deferred.

The combined total for traditional pre-tax deferrals and Roth after-tax deferrals is subject to IRS annual deferral limits adjusted for cost-of-living increases. For 2008, the combined limit is $15,500 or $20,500 if age 50 or older.  Participants can change between pre-tax and Roth but only prospectively. 

You will be receiving information from Paragon regarding restating your plan document.  This is required under The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of which the permanency of the Roth feature is also a part.  We will be reviewing your plan parameters for any changes and modifications that will help you better meet your company retirement objectives.  The addition of the Roth deferral may be an option worth considering.

As always, it is important to weigh the potential benefits of this feature against the additional employee communication and administration requirements, while taking into consideration the associated costs prior to implementation.  Please contact Paragon for more information.  We look forward to hearing from you.