The Treasury Department issued rules last week aimed at dismissing some of the uncertainties around Roth 401(k) plans.
Originally created as part of a 2001 law, the plans were to be eliminated after 2010, but the Pension Protection Act of 2006 made them permanent. The employer-sponsored savings accounts -- which don’t have any income limitations for participants -- are funded with after-tax money up to a certain contribution limit. After an employee reaches the age of 59-1/2, all withdrawals from the account, including investment gains, are tax-free. The plans are especially attractive to younger employees who think that they will be in a higher tax bracket when they retire.
The new Treasury guidance outlines the details of how the plans should operate, as well as simplifying the accounting treatment of the plans. The rules will also allow employers to consolidate Roth 401(k) holdings for an employee who had a Roth 401(k) plan with a former employer.
Finally, the Treasury guidance clears up the tax treatment for withdrawals by a person under 59-½ year, or who hasn't been contributing to the plan for at least five years. In such cases, gains made within the Roth 401(k) are taxable upon withdrawal, and are subject to a 10 percent premature distribution penalty, though the principal contribution remains exempt.
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