The Roth 401k allows participants to contribute after-tax dollars but then withdrawal tax-free dollars during retirement. This way, you can spend more on that retirement beach front property, and send less money to the IRS.

Unlike the Roth 401k, participants using traditional 401k accounts contribute pre-tax dollars that reduces taxable income. However, the dollars contributed are taxed as income when withdrawn during retirement. Because the Roth 401k offers tax-free retirement income, it is an attractive options for participants who will be in a higher tax bracket during retirement, or wish to diversify the tax treatment of retirement investments.

Roth 401K vs Traditional 401K Comparison
The Roth 401K has many similarities to a traditional 401k. The investment options for both accounts are the same, and investments in both accounts grow tax free between the time money is contributed and withdrawn.

Also, there is no difference in matching contributions. If the employer offers a matching contribution, participants using a Roth 401K will receive the same contributions as participants using the traditional 401k. However, the matching contribution for a participant in a Roth 401K plan must be invested in a traditional 401k account. This should be done automatically.

The process in both accounts are mostly the same. Participants elect the percentage of salary to contribute. Contribution must be within IRS limits, and the contribution is based on the participant’s eligible compensation. Participants can also choose to divide contributions between the Roth 401k and traditional 401k.

The central difference between the Roth 401k and the traditional 401k is how the accounts are taxed. Participants using a traditional 401k contribute pre-tax dollars. This lowers the participant’s taxable income, reducing the tax bill for the year the contributions are made. However, traditional 401k distributions made during retirement are taxed. This means that the participants would be taxed on all investment appreciation in addition to the original pre-tax contributions.

Participants using a Roth 401k, contribute after-tax dollars. This means that the participant’s tax bill would be larger in comparison to the bill of the same person contributing to a traditional 401k. The huge benefit of the Roth 401k is that retirement distributions are not taxed. This can be a great savings. In addition, participants can rollover the Roth 401k in a Roth IRA after termination of employment. This means that money can continue to grow tax free for as long as it is invested because there are no required minimum distributions for a Roth IRA.

Contribution Limits
The Roth 401k contribution limits are the same as the traditional 401k. The maximum contribution for 2007 is $15,500. For people 50 or older, a catch-up contribution of up to $5,000 can be made. Note that contribution limits are the same for participants using both the Roth and traditional 401k. Participants using both accounts cannot contribute twice the size of the maximum.

Roth 401K Distributions
Roth 401k distribution rules are somewhat of a mix between the Roth IRA and traditional 401k distribution rules. Participants have the same access to money in a Roth 401k account as in a traditional 401k account. Money can be taken any time from the Roth 401k, after employment termination. However, prior to termination, money cannot usually be withdrawn unless participants qualify for a hardship distribution.

Qualified Distributions
Roth 401k qualified distribution rules are similar to the Roth IRA. To make a qualified distribution, the Roth IRA account must be at least 5 years old and the participant must be at least 59.5 years old or disabled. The 5 year age requirement means that the participant must have been using a Roth 401k for at least 5 years. For example, if a participant had a Roth 401k account for 2 years, and the transferred that account to a different employer for 3 years, the total age of the Roth 401k account would equal 5 years.

Non Qualified Distributions
The rules for non qualified distributions are somewhat different. If a participant needs to withdrawal money from the Roth 401k and does not meet the qualified distribution requirements above, the participant must make a non qualified distribution. When taking a non qualified distribution, the taxable income is reported as a proportion of the investment earnings. For example, if a Roth 401K account is composed of 85% contributions and 15% earnings, 15% of a non qualified distribution would be taxable income. This differs from a Roth IRA, in which contributions can be withdrawn tax-free at any time.

Who May Benefit from the Roth 401k?
1. Wealthy participants who are not eligible for a Roth IRA, but want a tax-free investment to withdraw from during retirement

2. Young investors who anticipate being in a higher tax bracket during retirement.

3. Investors who want to pass tax-free investments to heirs.

In addition, the Roth 401k provides tax treatment diversification. Because future tax rates are uncertain, using accounts with different tax treatments reduces the impact of tax rate changes on retirement investments.

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