Roth Ira

The question arises, what is a Roth IRA 401(k)? Turning back the pages of history to 1978, it was in that year that the U.S. Congress looked into a method of getting people to save more money for their retirement. Far too many workers were looking to Social Security to sustain them, and this was not good. After all, that program was enacted back when the life expectancy was far lower than today.

It was never intended to support so many people for so many years. The funds were to augment people's income, not replace it. So, Congress decided that if people were given a way to save, which also lowered their federal and state taxes, they would use it. The result: the Tax Reform Act. Under Section 401, paragraph (k) tax-deferred savings accounts for workers were created, the co-called Individual Retirement Accounts (the IRA). The plans eventually became known as "401(k)", for an obvious reason.

The accounts are made of four features. First, the worker can put in up to fifteen percent of their monthly gross salary (up to a maximum of $15,000 annually). Second, the contribution is removed from their paycheck before taxes are even determined. As a result, the monies are removed before the worker ever gets the check; therefore, before they even have a chance to spend it. As a result, it is a rather painless way of saving money for retirement. Third, and this is not always true, the worker's employer may elect to match a portion of what the worker puts into the account. And finally, the money is then turned over to a third party who invests the funds in stocks, bonds etc. As to where the money is invested, those decisions are made by the worker based on a list of available investment options.

Then, in 1997, the Taxpayer Relief Act created a different sort of IRA, the Roth IRA. With this type of account, taxes are paid on the contributions the worker makes, but the savings grow tax-free, and then the withdrawals will not be taxed at all, provided certain rules are obeyed. First, the recipient has to be older than age 59 years and six months. Second, the Roth IRA has to have been owned by the retiree for a minimum of least five years. Not a bad situation.

And then, in August of 2006, President Bush signed the Pension Protection Act into law. This law made the Roth 401(k) plan permanent. The Roth IRA is aimed at upper income taxpayers; and it is a much better deal. Yet, it does have its limitations. One feature of it is that the employee's gross annual income can not be above $100,000. Now sure, for the vast majority of workers, that is an easy rule to follow. On the other hand, there are many high level professionals who make more than that. Quite a number of them objected to this cap. Despite the fact that anyone making that much does not need any 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.