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Recent Changes to Roth IRA and Impact on Physicians

Joel Blau

 Roth IRAs have become an extremely popular option for those who prefer the unique advantage of being able to withdraw funds during their retirement years on a tax- free basis, as opposed to traditional IRAs where withdrawals are taxed as ordinary income.  The only real downside to Roth IRAs is that contributions are made on an after- tax basis, and are not tax deductible like with a traditional IRA.  Unfortunately, most urologists have not been able to utilize Roth IRAs due to their relatively high income levels.  Roth IRA eligibility phases out between $95,000 and $110,000 for single filers and $150,000 to $160,000 for married taxpayers filing a joint tax return.  Starting next year, however, highly compensated individuals who are currently not allowed to contribute to Roth IRAs, as well as younger workers expecting to be in higher tax brackets during their retirement years, will be able to take advantage of a new type of tax- advantaged savings plan called the “Roth 401(k)”.

As its name implies, the Roth 401(k) incorporates elements of both traditional 401(k) plans and Roth IRAs.  Part of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 and available beginning January 1, 2006, the Roth 401(k) allows workers to make greatly expanded Roth IRA contributions but without any income restrictions impacting eligibility.  Contributions for Roth IRAs in 2006 are limited to a maximum of $4,000 for taxpayers under age 50, and $5,000 for those 50 and older.  The Roth 401(k) maximum contribution level, on the other hand, will be subject to much more generous elective salary deferral limits.  Beginning in 2006, workers under age 50 will be able to contribute up to $15,000, while workers age 50 and older will be able to contribute as much as $20,000 in the new Roth 401(k) plan.  At that point, an employee currently contributing to a traditional 401(k) plan would have the option of simply having their contributions diverted to a Roth version of the plan.  That election would impact the amount of take home salary since the contributions will be made on an after-tax basis, as opposed to pre-tax contributions made into a traditional 401(k) plan.
While all of this appears quite straightforward, there are a few nuances to consider prior to making the switch.  First, matching employer contributions still must be made and invested in the traditional 401(k) account, not the Roth 401(k) account.  Even if the employee makes all of their contributions exclusively to a Roth 401(k) account, they would still owe tax on retirement withdrawals from funds contributed by the employer, which were made on a tax-deductible basis, as well as the earnings on those contributions.  Secondly, workers should also be aware that the annual deferral limits apply to all 401(k) contributions, regardless of whether they are made on a pre-tax or after-tax basis.  While employees are allowed to contribute to both types of 401(k) plans, contributions to the traditional plan may need to be reduced or discontinued to comply with the over limits.  Employees considering the Roth option should know that, like the traditional 401(k) but unlike the Roth IRA, they will be required to begin mandatory minimum distributions by April 1st of the year following attainment of age 70 ½.  This may be avoided by rolling over the Roth 401(k) to a Roth IRA, thus avoiding the minimum distribution rules. Lastly, to add to the confusion, it is uncertain if the Roth 401(k) will continue to be available after the EGTRRA provisions expire in 2010.

It is also important to understand that you cannot simply assume that your plan will be amended to allow after-tax Roth contributions.  Employers should contact their plan administrators to determine the feasibility of adding the Roth feature.  Interested employees should inform their employers that this is an option they would like to see included in next year’s retirement plan structure.

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