Wednesday, November 22, 2006

Roth 401(k) plans

Roth 401(k) plans and Roth 403(b)s -- which are generally available to employees at colleges and nonprofits -- are tailor-made for younger workers who have the money available to pay taxes now and who may very well wind up in the same, or an even higher, tax bracket in retirement.

With a Roth 401(k), or Roth 403(b), you pay taxes on your retirement-plan contributions when you make them -- but your withdrawals generally are tax-free. And, if you roll over your Roth 401(k) assets to a Roth IRA, you don't have to make any required withdrawals. With a regular 401(k) plan, in contrast, you contribute pretax dollars -- but you have to pay taxes on your withdrawals later. That's why people try to figure out their future tax bracket, and future income-tax rates.

Few people can predict those variables with any certainty. Another complication: Many people, particularly those with traditional pensions, postpone making withdrawals from defined-contribution plans for years and years after starting retirement. That makes it even tougher to predict the future tax situation.

Some people think that enormous federal deficit hanging over us may force the government to change the tax structure in the future. Meaning that you may pay lot more tax when you withdraw the money. The advantage with Roth 401(k) is that you pay the taxes now. Other advantage to opening a Roth 401(k) while you're working is that you can convert it to a Roth IRA when you retire. If you wind up not needing the money in retirement, you could leave a compounding, tax-free legacy to your heirs.

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