Roth Ira

So, what exactly is a Roth 401(k) IRA? To start with, back in 1978 the U.S. Congress was looking for a means of encouraging people to save money for retirement. After all, Social Security was meant to augment people's income, not replace it. It was thought that if people were given a way to save that also lowered their federal and state taxes, they might use it. The result was the Tax Reform Act. Section 401, paragraph (k) allowed for the creation of tax-deferred savings accounts for workers, Individual Retirement Accounts (the IRA). The plans eventually took the name "401(k)", for an obvious reason.

The accounts have four distinct features. First, you can put up to fifteen percent of your monthly salary (up to a maximum of $15,000 annually) into it. Next, your contribution is taken out of your paycheck before taxes are calculated. As such, it is also removed before you ever get your check, meaning before you can even spend it. So, it is a rather painless means of saving for retirement. Third, and this is not true in all circumstances, your employer may match a portion of what you put into the account. And finally, the money gets turned over to a third party who invests the funds in stocks, bonds etc. based on selections you make from a list of available investment options.

Then, in 1997, the Taxpayer Relief Act created a different sort of IRA, the Roth IRA. In this situation, taxes would be paid on the contributions the workers made, but the savings would grow tax-free, and the withdrawals would not be taxed at all, provided certain rules were followed. First, the recipient must be older than age 59 years and six months. Second, the Roth IRA must have been owned by the retiree for at least five years. Not a bad situation.

And then, in August of 2006, President Bush signed the Pension Protection Act into law, which made permanent the Roth 401(k) plan. The Roth IRA is aimed at upper income taxpayers; and it is a much better deal. However, it does have its limits.

One feature of it is that the employee's gross annual income must be below $100,000. Now sure, for the vast majority of workers, that's a cake walk. But, there are many high level professionals who make more than that. Not a few of them objected to this cap. Despite the fact that some people argued that anyone making that much had no need for special treatment, a one year exemption was slipped into the Pension Protection Act. In 2010, anyone, regardless of income, can convert their IRA to a Roth IRA. Leave to politicians to muddy the waters.