In a traditional 401(k) plan, introduced by Congress in 1978, employees contribute pre-tax earnings to their retirement plan, also called "elective deferrals". That is, an employee's elective deferral funds ($15,500 in 2007) are set aside by the employer in a special account and the funds are invested. Typically, employers also add funds to the account by contributing matching funds on a fractional formula basis (e.g., matching funds might be added at the rate of 50% of employees' elective deferrals). Both the elective deferrals, and the matching funds, are invested and grow on a tax deferred basis. Typically upon reaching the age of 59 and a half, the account owner begins to receive "qualified distributions" from the funds in the account, these distributions are then taxed at the ordinary income tax rates. Under a traditional Roth plan, first enacted in 1996, individuals, whether employees or self-employed, voluntarily contribute post-tax funds to an individual retirement account (IRA).
In contrast to the 401k plan, the Roth plan requires post-tax contributions, but allows for tax free growth and distribution, provided the contributions have been invested for at least 5 years. The amounts of income that can be invested in a Roth IRA are significantly more limited than those to a 401(k) are. For 2006, individuals are limited to contributing no more than $4,000 to a Roth IRA, if under age 50, and $5,000, if age 50 or older. Additionally, Roth IRA contributions are prohibited when taxpayers earn a Modified Adjusted Gross Income of more than $110,000, ($160,000 for married filing jointly).
The Roth 401(k) combines some of the best aspects of both the 401(k) and the Roth IRA. Under the Roth 401(k), employees can decide to contribute funds on a post-tax elective deferral basis, in addition to, or instead of, pre-tax elective deferrals under their traditional 401(k) plans. An employee's combined elective deferrals-- whether to a traditional 401(k), a Roth 401(k), or to both-- cannot exceed $15,500 for tax year 2007 if a participant is under 50; if they are over 50, they may contribute an additional $5,000. Employer's matching funds are not included in the $15,500 elective deferral cap. In general, the difference between a Roth 401(k) and a traditional 401(k) is that the Roth version is funded with after-tax dollars while the traditional 401(k) is funded with pre-tax dollars. Typically, the earnings on Roth contributions will be tax free as long as the distribution is made at least 5 years after the first Roth contribution.
It is easy for us to setup a customized 401K plan for your business.