1) What’s the difference between a Roth 401k and traditional 401k pre-tax deferral plan?
In a traditional 401k plan, annual contributions are made with pre-tax dollars (meaning BEFORE taxes have been paid). On the other hand, a Roth 401k plan requires annual contributions to be made with AFTER-tax dollars (after taxes have been paid). For example, if you earn $50,00 a year:
|Traditional 401k Plan||Roth 401k Plan|
|$50,000 Gross Income
($15,000) 401k Contributions
$35000 = Taxable Income
|$50,000 Gross Income
($17,500) Tax = 35%
$32,500 = Net Income
($15,000) = 401k Contributions
$17,500 = Take-home Pay
In a Roth 401k, the annual contributions ($15,000 in this example) grow tax-deferred up until the age of retirement. You cannot withdraw these contributions before the age of 59.5 (if you do, you’ll have to pay a 10% penalty).
2) How much can i contribute to a Roth 401K?
In the year 2006, the maximum annual contributions you can make to both a traditional 401k plan and the Roth 401k is $15000. For seniors 50 years old or over, the amount is $15000 + $5000 (known as “catch-up” contribution).
3) Do the Roth 401k Contributions have to remain in the plan for atleast 5 years, in order for the earnings to be tax-free?
Yes! The Roth 401k Contributions you make must remain in the plan for minimum 5 years in order for the lump-sum earnings to be tax-free at the time of withdrawal. Also, you must be 59.5 or more years old to withdraw the money (without being charged a 10% penalty or fee).
4) Does the minimum 5 year contribution period start as of the first Roth contribution, or there have to be 5 contributions in 5 years before earnings become tax-free?
As soon as you make your first Roth 401k contribution, the 5 year period starts at that time. The 2nd 401k contribution you make (in the 2nd year) CANNOT be counted as the start of the 5 year period.
5) How do Retirement Plans affect Social Security when you retire?
Retirement plans such as the Roth 401k, 457 plans and 403b plans do NOT affect social security benefits you will receive when you retire. However, be aware that social security is not considered to be your main retirement source of income, it is merely a supplement to the savings that you must have in order to survive during retirement.
For instance, if you currently make $50,000 a year, you will get 40% x $50,000 = $20,000 a year in retirement income (after the age of 65). Therefore, if you have a rich lifestyle or want to maintain the lifestyle you had during your working years, social security will not be enough for it.
6) What are 401k Catch-Up Contributions?
401k Catch-Up contributions are meant for people over the age of 50 that are allowed to contribute an additional $5000 (in 2006) on top of their maximum limit of $15000.
7) What happens to my 401k Retirement Account if my Employer goes bankrupt?
All your 401k retirement contributions are held in a separate trust fund managed by a custodian or administrator. Therefore, your employer has NO access to that money. You can therefore be rest assured that you will get your money back upon retirement even if your employer is bought out by another company, goes bankruptcy or merges with another firm.
8) When can i sign up for a 401k account with my new employer?
Most companies require new employees to work for atleast 6 months – 1 year before they are eligible for a 401k retirement plan. Other companies require employees to be 21+ atleast.