New Year, new savings possibilities
Here's a rundown of changes in retirement savings accounts and a look at the new Roth 401(k).
By Jeanne Sahadi, senior writer

NEW YORK ( "Have more money" is the naked version of many-a-New Year's resolution.

If that's your goal, you should know how much more you'll be allowed to save in qualified retirement accounts and learn about a new savings option a Roth 401(k) -- that may be available to you in 2006.

Here are the maximum contribution limits set by the federal government for this year:

401(k)s, 403(b)s, 457s and salary-reduction SEPs: Up to $15,000 if you're under 50; an additional $5,000 if you're 50 or older. Those limits are $1,000 more than they were for 2005.

Keep in mind, these are Uncle Sam's limits. Your employer may set the maximum you and your colleagues may contribute to your plan at a lower level.

Traditional IRAs: Up to $4,000 if you're under 50; an additional $1,000 if you're 50 or older. The same limits apply to a spousal IRA, which is an IRA for spouses who don't generate income.

This contribution limit for those under 50 is the same as it was in 2005. But the catch up contribution for those who are older has increased by $500.

What's also changed is the amount of income a married couple filing jointly may make and still qualify for a deductible IRA.

For those couples to qualify for a deductible IRA in 2006, their modified adjusted gross income (MAGI) must be below $85,000. That's up $5,000 from last year. The amount they may contribute starts to phase down once their MAGI reaches $75,000.

For all other taxpayers, the limits are the same as in 2005: They must have a MAGI below $60,000 and the amount they may contribute starts to phase down when their MAGI reaches $50,000.

Roth IRAs: Up to $4,000 if you're under 50; an additional $1,000 if you're 50 or older.

This contribution limit for those under 50 is the same as it was in 2005. But the catch-up contribution for those who are older has increased by $500.

You may only make contributions to a Roth IRA if your modified adjusted gross income (MAGI) is below $160,000 if you're married filing jointly or below $110,000 if you're a single filer. The amount you may contribute to a Roth starts to phase down once your MAGI reaches $150,000 as a joint filer or $95,000 as a single filer.

Hello, Roth 401(k)

Traditionally, your 401(k) contributions have been pre-tax, meaning they reduce your taxable income dollar-for-dollar the year you make the contribution, the money grows tax-deferred and you pay income taxes on it when you retire.

But this year, some employers will start offering workers an opportunity to contribute after-tax money into their 401(k)s that will grow tax-free. The new option is called a Roth 401(k) -- or a Roth 403(b) if you work for a non-profit. It's not a separate plan from your existing 401(k), but rather a new element to it.

If your company offers one, you will be asked first how much of your gross income you'd like to contribute to your retirement plan -- say, 15 percent. And then of that, you'll indicate how much you'd like to put in the pre-tax portion of the plan and the after-tax portion say, 7.5 percent in each

There are three key advantages to a Roth 401(k):

1) You can use one even if your income is too high to qualify you for a regular Roth IRA.

2) You can contribute far more to a Roth 401(k) than to a regular Roth IRA, which caps your contributions at $4,000. In your 401(k) whether your contributions are made pre-tax, after-tax or some combination of the two -- you may contribute up to $15,000 this year ($20,000 if you're 50 or older).

3) Any money you contribute and the earnings on those contributions may be withdrawn tax-free when you retire.

Depending on your situation, though, there are some potential drawbacks when you contribute to a Roth 401(k):

  • Your taxable income will be higher, and your take-home pay will be less. Say you make $100,000 and opt to put 15 percent of your income into your 401(k), half in a pre-tax account and half in a post-tax account. Your taxable gross would be $92,500. By contrast, if you'd put it all in pre-tax, your taxable gross would be $85,000.
  • You may be disqualified from other tax breaks. If your 401(k) is your only deduction and/or if your adjusted gross income would disqualify you from other tax breaks without the benefit of your 401(k) deduction, then you may lose out on other tax breaks as well. Say you're single and your AGI is just below the AGI limit at which you're disqualified from deducting student loan interest, or taking a child-tax credit. Then you get a $5,000 bonus and contribute to a Roth 401(k). "You've just killed your ability" to take that deduction or credit, said Wayne Bogosian, founder of the Personal Financial Education Group.
  • Company matches (and the returns they earn) will be treated as taxable. But it's still free money and you shouldn't pass it up. So be sure that you're contributing enough to your 401(k) -- either on a pre-tax or after-tax basis, or both combined -- to qualify for the full match, said enrolled agent David Mellem. (See correction.)
  • Your money can grow more quickly making pre-tax contributions to a 401(k). If you contribute $10,000 pre-tax to a 401(k), the full $10,000 will compound over time. But if you make the contribution after-tax, you'll only be investing the amount left over after taxes on that $10,000.That may be a disadvantage if you think you'll be in a lower tax bracket in retirement than you are now. That's because even with the tax bite, the distributions from your pre-tax account may still exceed the amount you'd have available to you in your after-tax account.

The presence of Roth 401(k)s is far from widespread. According to a recent survey by the Profit-Sharing 401(k) Council of America, only 17 percent of 401(k) plan sponsors say they will add a Roth feature to their plans. Another 35 percent said they do not intend to. And 41 percent said they were still undecided.

That may change. The IRS has just come out with its final regulations governing Roth 401(k)s, which gives plan sponsors more certainty. And, according to the Principal Financial Well-Being Index, a high percentage of workers at companies with less than 1,000 employees have heard of Roth 401(k)s and said they would participate in the accounts if they had the option.

Correction: The original version of this article incorrectly implied that employers can't match Roth 401(k) contributions. In fact, Roth 401(k) contributions are eligible for employer matches. But the match will be treated the same way as the employer match on traditional pre-tax deferrals. regrets the error. (Return to story.) Top of page

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