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Roth 401K a new option for employers

Beginning in January, employers may offer a new retirement savings account, the Roth 401(k).

Like the more-familiar Roth IRA, it provides no up-front tax deduction, so your contributions won't reduce your current taxable income. But all the money you withdraw in retirement — both contributions and earnings — is tax-free as long as the funds have been in the account for at least five years and the account owner is at least 59 1/2 years old.

The Roth 401(k) offers two big pluses over the Roth IRA: higher contribution ceilings and no income limits.

"The Roth IRA is the holy grail of retirement accounts, but we never started one because our income was right on the edge," says Trip Leonard, 34, a stay-at-home dad and self-described personal finance geek who writes about the subject on his own blog (www.musingmoney.com). "I don't mind paying taxes now if it means tax-free income in retirement."

Workers are barred from contributing to a Roth IRA once their income tops $110,000 for individuals and $160,000 for married couples. But for the first time, high earners will be able to take advantage of tax-free retirement savings, because the Roth 401(k) has no income limits. (However, anti-discrimination rules that sometimes limit contributions to 401(k) accounts by highly compensated employees — those who earn $95,000 a year or more — will apply.)

Trip's wife, Stacy Chagnon, 34, is the family breadwinner. Stacy, an advertising executive, already contributes the annual maximum of $14,000 to her company's 401(k). She asked her employer to consider offering a Roth 401(k) next year, when the maximum increases to $15,000; employees 50 and older can put away an additional $5,000 in 2006.

By contrast, the maximum contribution to a Roth IRA will be $4,000 in 2006 and $5,000 for those 50 and older who qualify for "catch-up" contributions.

Although companies are not required to offer Roth 401(k) programs, a recent study by human resources firm Hewitt Associates found that more than one-third of employers are likely to add them. Your employer may offer matching contributions to your Roth 401(k), but they must be held in a separate account, because the boss's money and earnings on it will be taxed in retirement.

The Roth 401(k) also offers some excellent estate planning benefits. Although account holders must start taking distributions beginning at age 70 1/2, you can circumvent that restriction by rolling over the money to a Roth IRA. You won't have to take mandatory distributions, and your heirs will inherit the money tax-free.