It is important to note however that Roth IRAs and Roth 401(k)s and Roth 403(b)s are not exactly the same. The big difference, and it’s an extremely important one, is that the new Roth 401(k) and Roth 403(b) plans are available to a much larger group of people. Roth IRA contributions are subject to adjusted gross income (AGI) limits. For instance, in 2007 they are only available to married couples filing jointly with an AGI of less than $166,000, single individuals with an AGI less than $109,000, and most married individuals filing separate returns with an AGI less than $20,000.

These restrictive AGI limitations (which are indexed for future inflation) do not apply to the new Roth 401(k) or 403(b) plans, which means higher income individuals and couples can gain entry into the tax-free Roth environment.This change provides an unprecedented ability for employees to expand or in some cases begin to benefit from investments that will grow tax-free. The 2007 401(k) and 403(b) employee contribution limits are $15,500 (or $20,500 if you are 50 or older) per year. It is important to note these numbers reflect total employee contribution limits. In other words you cannot make a $20,500 contribution to the traditional portion of the 401(k) plan and a $20,500 contribution to the Roth portion of the 401(k) plan.

There is one other difference between Roth IRAs and Roth 401(k)s and Roth 403(b)s. Roth IRAs are not subject to required minimum distributions (RMD). However, there are required minimum distributions from Roth 401(k)s and Roth 403(b)s. They are not taxable, but any distributions reduce the future tax free growth. This minor problem can be overcome, however. Upon retirement, simply roll the Roth 401(k) or Roth 403(b) into a Roth IRA. This will stop any future required minimum distributions on all the money for your entire lifetime.

Let’s Look at an Example to Clarify:
Joe, a prudent 50 year old employee, is a participant in his company’s 401(k) plan. He has dutifully contributed the maximum allowable contribution to his 401(k) plan since he started working. Until he heard about the new Roth 401(k), his expectation was to continue contributing the maximum into his 401(k) for 2007 and beyond.

Now, Joe has a choice. He could either continue making his regular deductible 401(k) contribution (which has increased to $20,500 for 2007) or he could elect to make a $20,500 contribution to the new Roth 401(k) or he could split his $20,500 contribution between the regular 401(k) portion and the Roth 401(k) portion of the plan. His decision will not have an impact on his employer’s contribution, either by amount or the way the employer’s contribution is taxed.

With Joe’s contribution, however, there is a fundamental difference in the way his traditional 401(k) is taxed and the way his new Roth 401(k) is taxed. The new Roth 401(k) is basically taxed like a Roth IRA. That is Joe will not get a tax deduction for making his contribution to the Roth 401(k), but the Roth 401(k) portion will grow income tax-free. With the traditional 401(k), Joe would get an income tax deduction for his contribution to the 401(k). However, after Joe retires and takes a distribution from his traditional 401(k), he will have to pay income taxes on that distribution. When Joe takes a distribution from his Roth 401(k) portion of the account, he will not have to pay income taxes. In Retire Secure! (Wiley, Sept. 2006), I analyze and compare the traditional retirement plan with the Roth IRA. The Roth IRA almost always comes out on top. For the same reasons that I prefer a Roth IRA to a traditional IRA, I prefer a Roth 401(k) and Roth 403(b) to a traditional 401(k) and 403(b).

Assuming Joe takes my advice and begins making contributions to the Roth 401(k), he will have three components to his 401(k) plan at work. He will have his employer’s portion of the plan which remains unchanged. He will have his original 401(k) which holds of all his previous contributions plus the interest, dividends and appreciation on those contributions, and he will have a Roth 401(k).

If Joe is married and his adjusted gross income is less than $156,000, then he may have already been making contributions to a Roth IRA outside of his employer’s retirement plan. As long as Joe is working, the Roth 401(k) will remain separate from any Roth IRA he may have outside of his employer’s plan. If his adjusted gross income was greater than $166,000, he was not eligible to make any Roth IRA contribution, but now he he will be eligible to make a contribution of up to $20,500 to his Roth 401(k). Thus high income earners will now have access to the "tax-free growth" world of the Roth, but it will be in the form of a Roth 401(k) or a Roth 403(b).

Married taxpayers with earned income and 2007 adjusted gross incomes of less than $156,000 are eligible to make maximum Roth IRA contributions outside of their employer’s retirement plan. The maximum contribution for 2007 is $4,000 for employees under 50 and $5,000 for employees 50 and older. For these individuals, what the Roth 401(k) and Roth 403(b) provide is a significant increase in how much money they can put into the Roth environment. These taxpayers could still contribute $5,000 to a Roth IRA outside of work and $20,500 to the Roth 401(k) plan at work.

These new Roth plans offer an opportunity to dramatically increase your tax-free wealth. Subject to a few exceptions, if you have access to a Roth 401(k) or Roth 403(b), I highly recommend you take advantage of that option and if you can afford it, contribute the maximum.

Notice, however, there is a caveat. I said “if you have access.”  Though Congress has created these Roth 401(k)s and Roth 403(b)s, that doesn’t mean your employer will adopt these plans--there are administrative costs. If they don't offer the Roth plans, a retirement plan administrator only has to keep track of the employer’s portion and the employee’s portion. If they do offer the Roth plans the administrator must keep track of the employer’s portion, the traditional employee’s portion and the employee’s Roth portion.

This could be a payroll and accounting burden, particularly for small firms. The additional cost of changing the terms of the retirement plan should not be significant but the cost of the extra accounting could be significant. Many smaller companies may choose not to offer employees the Roth 401(k) or Roth 403(b) options. Many employers will eventually offer Roth 401(k)s and Roth 403(b)s but will not do so immediately. You may not have access to these options until 2007 or 2008 or later, when your employer adopts the changes.

If you are a retirement plan administrator or owner of a small business, if you have not already considered implementing a Roth 401(k) or Roth 403(b), I would strongly consider it.

If you are a financial advisor, you should call your working clients and tell them to switch to a Roth 401(k) or Roth 403(b) as soon as they are offered.