Roth 401(k) – Saving for the Future the New Old-Fashioned Way

Like lime in your Diet Coke and caramel in your Hershey Kisses, Roth 401(k)s combine some familiar elements into an exciting new opportunity to save for retirement.


The progress of America’s baby-boomer generation into retirement is a landmark event, and people are paying attention.   For some, it has called to the forefront concerns about weaknesses in the Social Security system and has increased focus on private retirement options.  Last year’s introduction of the Roth 401(k) option allows employers to offer an additional alternative to consider.

There’s Chocolate in My Peanut Butter!  There’s Peanut Butter on My Chocolate Bar!
The Roth 401(k) plan is a hybrid retirement plan combining elements of traditional 401(k) plans and the popular Roth IRA.  The key issue is the fundamental difference in how a standard 401(k) is taxed versus how the Roth 401(k) is taxed.  Like its big brother, the Roth IRA, contributions to the Roth 401(k) are not tax deductible, BUT they grow income-tax free and post-retirement withdrawals are completely tax-free. 

Comparison of Tax Treatment


Traditional 401(k)

Roth 401(k)




Account growth prior to withdrawal

Not taxed

Not taxed


Taxed at current income tax rate


Adopting the Roth 401(k) option is a fabulous opportunity for you and your staff to add to retirement savings.  Even individuals unable to participate in Roth IRAs because of income limits are allowed to contribute to the Roth 401(k).   Sweetening the deal even further, employees can save more with a Roth 401(k) than with a Roth IRA.  This year’s contribution limit for the Roth 401(k) is $15,500 ($20,500 for individuals 50 or older by December 31, 2007).  The 2007 limits for older brother Roth IRA limit is $4,000 ($5,000 for those 50 or older).

For Example . . .
Let’s examine the Roth 401(k) opportunity of an employee turning 50 in 2007 who is in the 33% federal tax bracket.  That person could save $15,500 in the Roth 401(k) plus add in the $5,000 above-50 catch up.  These being after-tax contributions, this would result in $6,765 in federal income taxes on that $20,500 income (State and local taxes are too varied, so we’ll just leave them out of this particular example).  Continuing to max out the contributions for the next five years (since Congess took action to extend the program past the original stop date of December 31, 2010), would result in $102,500 that has already been taxed.  Provided this contributions were made monthly over the course of the five years and prudent investing resulted in an 8% return, at age 55 that employee would have $125,523.  One can overlook the fact they would not be able to take a distribution on that amount for another four and one-half years by speculating on how the magic of compound interest would help that amount grow even if they were not able to continue to make additional contributions.

Making a final decision
From the employer side, there are administrative and accounting issues that need to be evaluated – including amending your company’s plan.   Payroll records must display after-tax Roth 401(k) contributions separately from standard pre-tax 401(k) contributions.  Lastly, the third-party administrator will need to know when to start separate recordkeeping.

There may be additional paperwork and a slight increase in recordkeeping and administration costs associated with adding the Roth 401(k) to your retirement plan.  Still, giving employees an additional tool to help plan and finance their retirement option resonates in tune with the credit union philosophy.




Jan. 22, 2007



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