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Flex Your 401(k): Roth Option

A new kind of retirement plan allows tax-free withdrawals.

U.S. employers are starting to offer a new kind of retirement savings plan that allows workers to withdraw money tax-free.

The Roth 401(k) combines features of the traditional 401(k) with those of the Roth individual retirement account. As with the Roth IRA, contributions are made to Roth 401(k)s with after-tax dollars. While you won't get an upfront tax-deduction, the account will grow tax-free, and withdrawals taken during retirement will not be subject to income tax, provided you're at least 59 1/2 and you've held the account for five years or more.

But unlike Roth IRAs, which are subject to income limits, depending on your tax filing and marital status, employees can contribute to a Roth 401(k) regardless of how much they earn.

"The real advantage of the Roth 401(k) is it gets more money working for you, tax-deferred," says Christine Fahlund, a senior financial planner at T. Rowe Price. For example, she says, if you contribute $15,000 to a Roth 401(k), you do so on an after-tax basis, so all the returns on that money are yours to keep. But if you contribute $15,000 in pretax money to a traditional 401(k), not all of that money will be working for you; some will be working for the government, because it's taxed as income when you eventually withdraw it.

"I would say the Roth 401(k) is advantageous to anyone of any age who doesn't need an income tax deduction," Fahlund says. She notes that you can contribute to both regular 401(k) and Roth 401(k) sub-accounts of the same plan.

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While the conventional wisdom is that it makes sense for older workers to contribute to a regular 401(k) because they can expect to be in a lower tax bracket when they retire, Fahlund says that's not necessarily the case. "Part of that argument is that we don't know where the marginal tax rates are heading with this huge deficit we have. Tax rates could rise dramatically in the future, and you don't know what your bracket will be when you retire."

Employers have been able to offer Roth 401(k)s only since Jan. 1, 2006, but these plans are slowly being adopted. In a survey late last year of 146 U.S. companies by benefits consulting firm Hewitt Associates, 12% of respondents already offered Roth 401(k) accounts, while 32% of the remaining respondents were very likely or somewhat likely to offer them in 2007.

Among the companies that were very unlikely or somewhat unlikely to add a Roth 401(k) account, 67% said that it must be clear that employees would use the Roth 401(k) before adding one. Forty-six percent of the employers in these categories cited administrative complexity as a barrier, closely followed by 43% who are concerned about the complexity of communication about the plan.

Roth 401(k) accounts are subject to the same contribution limits as regular 401(k) accounts; $15,500 for 2007, or $20,500 for those who are 50 or older by the end of the year.

Steve Viuker is a Brooklyn, New York-based business and finance writer. He has been published in The New York Post, The New York Times and other national media outlets.