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Designated Roth 401(k) Accounts

Is your company considering the addition of designated Roth accounts to your current 401(k) plan? Read on for a question and answer summary on this hot topic.

SITUATION: Several of our employees have asked us to add designated Roth accounts to our 401(k) plan. We want to remain competitive to attract and retain qualified employees but are unsure whether we should add this feature.

QUESTION: Do many other 401(k) plans offer designated Roth accounts?

ANSWER: According to the Plan Sponsor Council of America’s (PSCA) 55th Annual Survey of Profit Sharing and 401(k) Plans, an increasing percentage of 401(k) plans are offering their participants the option to make after-tax designated Roth contributions. In 2011 (the most recent data available), 43.4% of the 401(k) plans surveyed offered designated Roth accounts. That’s an increase of almost five percentage points from 2010, when 38.7% offered this feature.

DISCUSSION: In addition to helping your company recruit and retain qualified employees, adding a designated Roth account option may increase plan contributions. By offering Roth contributions, you can provide all employees — including higher paid employees and owner-employees who may not be able to contribute to a Roth IRA due to the tax law’s income restrictions — more flexibility in how they can save for retirement. Note: Your 401(k) plan must continue to offer traditional pretax contributions as well.

Offering Roth contributions may also encourage a greater number of younger and lower paid employees, who would pay little tax on their contributions now, to participate in your plan. Higher participation makes it easier for your plan to satisfy the annual nondiscrimination tests. Designated Roth account contributions are counted with other contributions when testing the plan.

For employees: Earnings on after-tax designated Roth contributions can grow tax free, and both contributions and earnings can be distributed tax free after five tax years have elapsed since the first designated Roth contribution and the participant is age 59½ or older. After five tax years, distributions made on account of the plan participant’s death or disability are also tax free. In 2013, plan participants can contribute up to $17,500 ($23,000 if age 50 or older) to a designated Roth account versus $5,500/$6,500 to a Roth IRA.

CONSIDERATIONS: Adding a Roth 401(k) option is relatively simple, but be aware that some additional administration and expense will be involved.

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