Effective for plan years beginning on or after January 1, 2006, employers can add a Designated Roth 401(k) feature to their 401(k) retirement plans. A Roth 401(k) feature allows participants to make after-tax 401(k) deferrals. A traditional 401(k) deferral is pre-tax. An individual still has one overall deferral limit. For 2012, the limit is $17,000 for under age 50 and $22,500 for over age 50. An individual can elect 100% of their deferrals to be Roth or pre-tax, or they can split the election in any percentage they choose.
Since Roth 401(k) deferrals are after-tax, they are not taxed when the money is distributed. How the earnings are taxed depends on whether the distribution is qualified or non-qualified. If the distribution is qualified, then the earnings are not taxable to the participant. If the distribution is non-qualified, then the earnings are taxable to the participant. A qualified distribution is a distribution that is made after a 5-taxable-year period of participation and that is made either after the date the employee attains age 59 ½, after the employee’s death or after the employee becomes disabled. The 5-taxable-year period of participation begins on the first day of the employee’s taxable year for which the employee first had designated Roth contributions made to the plan and ends when 5 consecutive taxable years have passed.
Adding a Designated Roth 401(k) feature provides employees the choice to have their deferrals taxed currently or to have them postponed until the money is distributed from the plan as a taxable distribution. One advantage of the Roth 401(k) is that the participant has the potential never to be taxed on the Roth 401(k) earnings, provided the distribution is considered a qualified distribution.
~Glenn Bowman, QKA, QPA, CPC