The Expanding "Roth" Retirement Account

Alicia Waltenberger, TIAA-CREF
Douglas Rothermich, TIAA-CREF
William Reichenstein, Baylor University and TIAA-CREF Institute Fellow

March 2006 |

Starting in 2006, many plan participants may have a new vehicle for retirement savings, called the Roth 401(k) or Roth 403(b). This paper discusses the most relevant factors to help participants make the decision between funding a traditional 401(k)/403(b) account or a Roth 401(k)/403(b) account. Factors that increase the attractiveness of the Roth 401(k)/403(b) include:

• You are in a lower income tax bracket now than you expect to be during retirement.
• You want to take advantage of the effectively larger contribution limit by contributing after-tax dollars.
• You want to minimize required distributions after age 70½ (Section 3 discusses planning for required minimum distributions with Roth IRAs).
• You have more retirement assets in tax-deferred accounts like the traditional 401(k)/ 403(b) than in taxable accounts.
• You are concerned about estate tax issues.
• You currently do not itemize deductions or have deductions subject to Adjusted Gross Income (AGI) limits.
• You suspect distributions in retirement from traditional 401(k)/403(b) accounts will subject your Social Security income to taxes.

Factors that tend to favor the use of traditional 401(k)/403(b)s include:

• You are in a higher income tax bracket now than you expect to be during retirement.
• A reduction in this year’s AGI would be beneficial for tax planning purposes.
• You believe the United States is going to a flat tax or consumption tax.

In many ways, the new Roth 401(k)/403(b) accounts are similar to Roth IRA accounts: Contributions to these accounts are not tax deductible but returns (e.g., distributions in retirement) are generally income tax-exempt. However, the Roth IRA, which became available in 1997, has income thresholds that prohibit participation by higher-income individuals and impose contribution limits that are far lower than those in employer-provided plans. In contrast, the new Roth 401(k)/403(b) accounts do not have income thresholds and allow much larger contributions.

In sum, under the right circumstances the new Roth accounts allow participants significantly more flexibility in their tax planning and may be worthy of consideration by those who have access to them.