Roth 401(k) Plans The Numbers Don’t Lie
The New Roth 401(k) Plan
A new retirement account was signed into law on August 17, 2006. It is a component of a “regular” 401(k) plan; however, the funding of a “Roth” 401(k) plan is funded with AFTER-TAX dollars. This is similar to the Roth IRA but with higher funding limits and no limit on earnings to contribute. Money contributed to a Roth 401(k) plan grows without tax and is distributed without tax. (In 2007, the funding limit is $15,500 ($20,500 if over the age of 50)). Who should use a Roth 401(k) Plan? -Anyone who will be retiring with the same or higher tax-bracket. -Anyone who will be retiring with a tax-bracket within 10% of their current tax-bracket. For example, if you are in the 40% tax bracket and retire in the 30% tax bracket, using a Roth 401(k) is still a better financial tool. An example is really the best way to crystallize the benefits of a Roth 401(k) plan and when it is appropriate to use one. For this example, assume the client (age 40) contributes $15,000 to a Roth 401(k) plan each year for 25 years and takes distributions from the plan from age 66-85. Because the contribution is non-deductible to the plan, the client will have to pay the following taxes on his/her contribution: -40% tax bracket = $6,000 tax -30% tax bracket = $4,500 tax -15% tax bracket = $2,250 tax Assume a 7% investment returns over the life of plan. For a comparison example, the client will invest an amount of money equal to the taxes he/she would have saved in taxes had a "regular" non-Roth 401(k) been implemented (a side account). -$6,000 for the client in the 40% tax bracket -$4,500 for the client in the 30% tax bracket -$2,250 for the client in the 15% tax bracket When clients actively invest money in the stock market after tax, in order to have a real world example, the numbers must reflect a capital gains/dividend taxes on the post-tax brokerage. The following are the assumed annual taxes on the growth in the account. -25% for the client in the 40% tax bracket -20% for the client in the 30% tax bracket -15% for the client in the 15% tax bracket How much can this client receive in retirement from him Roth 401(k) plan? $60,831 from the plan income-tax free every year for 20 years (66-85). If the client instead funded a regular taxable 401(k) the following is how much the client could receive from ages 66-85 after-tax?
-$36,498 in the 40% tax bracket -$42,581 in the 30% tax bracket -$51,706 in the 15% tax bracket The above numbers must be added to the side account the client would have funded with the extra dollars he would have had from funding a deductible 401(k) plan. From the side account, the client could receive the following amounts after tax from ages 66-85. -$18,063 in the 40% tax bracket -$14,510 in the 30% tax bracket -$7,769 in the 15% tax bracket Totaling the numbers: From a regular 401(k) plus side account after-tax the client would receive the following from ages 6685: -$54,562 in the 40% tax bracket -$57.092 in the 30% tax bracket -$59,475 in the 15% tax bracket Who wins? Since the client could receive $60,831 from a Roth each year, the client who funds a Roth 401(k) wins.
Manipulating the numbers
What if the same client starts in 40% income-tax bracket and then drops down to 30% in retirement? He/she could take out $60,645 over the same time period. What if 30% and then 15%? $66,216.78 What if 30% and then up to 40%? $51,008 What if 40% and then 15%? $69,770
Simply put, Roth 401(k) plans are financially beneficial for nearly every client. Do you use a Roth 401(k) plan? If not why not? Probably because your current advisors are not familiar with them and/or proactive with their advice. For help determining if a Roth 401(k) plan can help you in your business, please contact our office for help at …