The IRS has recently released final regulations concerning Roth contributions to a 401(k) plan. The ability to make Roth contributions to 401(k) plans and 403(b) plans will be effective for taxable Plan years beginning on or after January 1, 2006. If permitted by plan provisions, participants may designate that all or a portion of their elective deferrals be treated as Roth contributions. The designated Roth elective deferrals are taxed in the same manner as Roth IRA contributions; (contributions are subject to current income tax while withdrawals of both contributions and income are tax-free).

• Elective contributions that are made after tax (also 100% vested)
• No income limits (Roth IRA's have limits)
• Designated irrevocably whether pre-tax or after-tax by employee at time of deferral elections
• Cannot reclassify pre-tax 401(k) accounts as Roth accounts or vice versa
• Combination of pre-tax and Roth 401(k) subject to 402(g) limits ($15,500 in 2007 plus $5,000 catch up)
• Subject to ADP testing unless 403(b). If ADP test fails, HCE can designate whether corrective refunds come from Roth or Pre-tax. Earnings are taxable. (This testing could limit highly compensated employees)
• Subject to top heavy, annual additions rules, etc. (call Paragon for details)
• Separate accounting is required by your record keeper
• Roth contributions and earnings are not taxable upon qualified distribution (distributions are qualified only after: 5 years of deposit AND age 59½, death or permanent disability)
• Largely the same distribution restrictions as 401(k) pre-tax deferrals (includes age 70.5 required minimum distributions while Roth IRA's do not).
• Balances can only be rolled over TO another designated Roth 401(k) account or Roth IRA
• Cannot roll Roth IRA balance INTO a Roth 401(k)

• Need to amend your plan document
• More detailed operational guidance from IRS
• Payroll systems must be able to accommodate these contributions
• Recordkeeping systems must be able to track Roth 401(k)'s separately
• Obtain employee communication tools and forms from plan service providers
• If utilizing auto cash out provision (more than $1,000) must be able to rollover to Roth IRA

We feel that this provision includes some powerful tax benefits and planning opportunities that could be worthwhile for some plan sponsors. The economic benefit of a Roth 401(k) as opposed to the traditional 401(k) deferral really is impacted by the tax brackets in place when dollars are contributed and withdrawn. In most cases where the tax brackets are equal, there is no real economic benefit to either method. The reason for this is that in order to save under the Roth 401(k), more real dollars have to be saved since there is no immediate tax advantage on the actual contribution.

On the other hand, the provision will add additional administration along with the potential resulting expense. Due to the fairly complex tax rules associated with this provision, it may be difficult to effectively communicate to employees. History has taught us that if employees do not understand the features of a plan, they typically will not participate. Because these contributions will be tested, thorough employee communication and participation at most pay levels will be required for the feature to be a success.

• Certain highly compensated employees (HCE's) are not allowed to participate in a Roth IRA. These HCE's may wish to bypass today's tax savings in order to receive tax free distributions at retirement.
• Employees who wish to defer more dollars on an after-tax basis (2007: $15,000 plus $5,000 catch up vs. $4,000 plus $1,000 catch up in a Roth IRA)
• Low income taxpayers that understand the benefits (i.e., may be in a much higher tax bracket when they retire). Please note these employees are most likely also eligible for a Roth IRA
• Participants that roll Roth 401(k) accounts into Roth IRA's may avoid minimum required distributions (70 1/2) prior to death.