I asked today if my company has any plans to offer a Roth 401k to it's employees. If you've not heard about the new Roth 401k plan then pay attention. At the beginning of this year, a new law went into effect. This allows you to put after-tax dollars into a 401k retirement account. The nice thing is that your interest earnings can then be taken out tax free once you meet the qualifications (basically 59.5 years of age). How is this different from a normal 401k? A normal 401k plan lets you put before-tax dollars into a tax sheltered account. Your investments grow tax free but when you take the money out, you are taxed on that withdrawal as income. Both qualify for employer-match programs (although your employer puts the match for a Roth 401k into a normal 401k account.
Here is an example. Let's say you make $70,000 and are 30 years of age. If you decide to put 10% in your retirement account. We'll pretend your tax rate is 20%.
| Roth 401k |
Normal 401k |
| take home salary |
$49,000 ($70k taxed at 20% = $56k - $7k deposit) |
$57,400 ($70,000 - $7,000 = $63k taxable at 20%) |
| difference in take home salary |
$8,400 |
| amount invested |
$7,000 |
$7,000 |
| amount in retirement account in 30 years |
$65,220 |
$65,220 |
| taxed amount from retirement account |
$0 |
$13,044 ($65,220 taxed at 20%) |
So, assuming my math is correct in this simplified example; if you take an $8k hit today you save $13k in 30 years. That's with a single $7k deposit. Now, that seems like a large hit to take today but in the long run that works in your favor.
Plus, you can roll an existing 401k into a Roth 401k and take a 1 time tax hit. So lets say that instead of taking an $8k hit in your salary, let's say you turn your $8500 401k into a $7k Roth 401k. Now you get to save that $13k in future taxes at essentially no cost to yourself today!
Sounds good, right? Of course, for anyone to take advantage of this, your company must offer a Roth 401k retirement plan option. It seems that my company won't be offering me this option for the following reason. Apparently the IRS requires that companies hire auditors to "test" 401k plans. Each 401k plan must be individually tested. According to my HR manager, each annual test costs $10,000. Because I work at a company with a lot of hourly and low paid people (it's a retail company) there isn't a lot of particpation in the 401k plan. We're hovering somewhere around 3%. We don't even average at the company match amount (4%)! So, because there is such low participation, that 2nd plan is too expensive for the company to justify.
Sucks.