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Ed Slott's Free IRA Update

July 2009

Volume 2, Number 7

In This Issue

·         Focus on – Is a Roth 401(k) for You?

·         Question of the Month

·         News, Rulings and Other Updates

·         Retirement Planning Tip

·         Ed Slott's IRA Advisor – July Issue














































Emerald Publications













Ed Slott's Exclusive 2-Day IRA Workshop - Instant IRA Success


July Focus:  Is a Roth 401(k) Right for You?


The Roth 401(k) has piqued the interest of many individuals because it provides an opportunity for tax-free earnings. But even the savviest investors are sometimes unsure of how to determine if a Roth 401(k) is better than a traditional 401(k). In this issue, we focus on two of the key factors which can be used to determine if a Roth 401(k) is more suitable for you than a traditional 401(k) account.


1.     Pre-tax Contributions Reduce Your Income Tax – But Roth Contributions do Not!


Pre-tax salary deferral contributions to your traditional 401(k) reduce the amount of income tax withheld from your paycheck. As a result, a portion of the cost of funding your retirement account is offset by the reduction in the income tax that you would owe.



Assume you earn $5,000 per month. Depending on your tax withholding rate, a pre-tax salary deferral contribution of 10% ($500) to your 401(k) would reduce your take home pay by about $344, instead of the full $500. This is because when you defer $500 on a pre-tax basis, $4,500 ($5,000 less $500) would be subject to income tax, instead of $5,000, resulting in your income tax withholding being reduced by about $155.


As a result, it would cost you only $344 to make the contribution of $500. Let’s compare a sample paycheck of $5,000 for a New Jersey resident, where a pre-tax salary deferral contribution (labeled as “Voluntary retirement plan contribs.” below) of $500 was made in one instance and where no contribution is made in another.






Current (for 2009)

Alternative (for 2009)

Gross pay for one pay period




Federal income tax



State and local income taxes (NJ)



Social Security and Medicare taxes



Voluntary retirement plan contribs.



Mandatory retirement plan contribs.



Other pre-tax reductions



Other after-tax reductions




Take-home pay




Net cost (reduction in paycheck)





Paycheck Comparison Calculator available here.


As you can see, making the contribution of $500 reduces the take home pay by only $344.


Contributions to your Roth 401(k) do not reduce your income tax because they are made on an after-tax basis. As such, when choosing between funding your traditional pre-tax 401(k) and your Roth 401(k), your options would be:

(a)   reduce your contributions from $500 to $344 so as not to affect your take-home pay, or

(b)   contribute $500 and reduce your take home pay by $155.


If you are working with a tight budget, option 1 may be the better choice.


1.     Roth 401(k) Distributions Can be Tax-Free, Traditional 401(k) Distributions are Taxable


Distributions from your Roth 401(k), including earnings, are tax-free if distributions are qualified; on the other hand, distributions from your traditional 401(k) generally would be fully taxable. If we compare $500 being added to a Roth 401(k) with $500 being added to a traditional 401(k) on a monthly basis over a twenty year period, the total account balance would be $183,998.59 for each (assuming a 4% rate of return); but a complete analysis looks beyond this basic comparison and requires your financial advisor to take other factors into consideration, such as:


  • If you choose to contribute $500 to a Roth 401(k), the true cost would be $500 vs. the cost of $344.50 to fund your traditional 401(k). As such, funding your traditional 401(k) leaves an additional $155.50 to invest, which could offset the income taxes that would be owed on future distributions from these funds.
  • Other sources of income you may receive during retirement and how the taxable income from your retirement assets would impact the amount of income tax you pay on those amounts.
  • Whether your legacy planning objectives include leaving tax-free or taxable retirement assets to your beneficiaries.


There are other factors that should be considered when conducting a Roth vs. traditional 401(k) analysis, and it should be noted that the outcome will vary for each individual based on his specific circumstances.





Comparing the features and benefits of both types of 401(k)s can assist in making the determination of which plan is more suitable for you based on your individual circumstances. However, in order to make an informed decision, you will need to work with a financial advisor who understands how your 401(k) contributions impact your retirement savings, as well as how each option affects your specific set of retirement needs and financial profile. If you are unsure of whether a Roth 401(k) fits your financial profile, you may want to contact an Ed Slott Elite IRA Advisor.


Explanations of the rules that govern IRAs are usually provided in Ed Slott's IRA Advisor Newsletter. If you are not already a subscriber and want to get an idea of the content of the newsletter, you can preview past issues before subscribing.


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Question of the Month

Question:  I own a small business and want to set up a Roth 401(k) for myself and my employees. However, I have contacted several local financial institutions and none of them seem to offer Roth 401(k) plans. All of the paperwork with which I was provided by these institutions only indicates”401(k) Plan.” Is the Roth 401(k) available as of yet?


Answer: Yes. The Roth 401(k) became available as of January 1, 2006. Bear in mind that the ”Roth 401(k)” is a feature within a regular 401(k) plan and cannot be set up as a standalone plan. As such, a 401(k) adoption agreement may allow you - as the business owner - to make an election as to whether you want to include the Roth option as a feature available to your employees within your 401(k) plan. Double check the paperwork you received, and if the Roth 401(k) is not an option you may need to find another 401(k) provider 


News, Rulings and Other Updates



PLR 200925044: Partial Transfer Results in Modification of SOSEPP


A taxpayer started a series of substantially equal periodic payments (SOSEPPS) from one of her IRAs with the payments running from 2002 to 2008. Sometime during the SOSEPP period, she transferred a portion of that IRA balance to a new IRA. The new IRA also received a transfer from yet another IRA.


The IRS ruled that the partial transfer resulted in a modification presumably because it was co-mingled with funds from a non-SOSEPP IRA. As a result of the modification, she is required to pay the entire 10% early distribution penalty that was waived under the SOSEPP, plus IRS assessed interest. Details of the ruling and link to the PLR are available here.




July’s Retirement Planning Tip:  Still Fund Your 401(k)


If you are close to your planned retirement age and feel like you are behind the eight ball with your savings, consider playing catch-up. If you are age 50 or older on December 31, you are allowed to make catch-up contributions to your retirement accounts. If you can afford to contribute the maximum catch-up amounts, it could add a significant amount to your retirement nest egg.


  • For 401(k), 403(b) and governmental 457(b) plans, the catch-up limit is $5,000. Over a ten year period, this could add up to about $62,000 assuming a 4% rate of return.
  • If you participate in a governmental 457(b) plan as well as a 401(k) or 403(b) plan, you can contribute $5,000 to each, bringing the total to $124,000.
  • For IRAs, the catch-up is $1,000, which could add up to about $12,000 over a ten year period.


Consider also that an employer plan catch-up contribution of $5,000, if made on a pre-tax basis, results in a substantial savings due to the reduction in the amount of income tax you would pay for the year (see example in lead article above). Use the take-home pay calculator here to see how pre-tax contributions affect your take home pay.



Highlights from Ed Slott's IRA Advisor Newsletter - July 2009 Issue


Your July 2009 issue of Ed Slott’s IRA Advisor newsletter is now available online. You may access your newsletter by clicking or copying the link below into your browser: http://irahelp.com/membersarea/newsletters.php

It's a new era for Roth IRAs!
Looking for something to let your clients know how valuable you are?
How about an encouraging message about the very real possibility of a tax free retirement? You can make it happen, beginning right now.
Enjoy this special issue of our newsletter devoted to Roth IRA Conversion Planning for 2009 and 2010. It's packed with planning ideas and tax strategies to share with your clients.
Right now, while tax rates are still low, you have a unique opportunity to help your clients keep more of their retirement funds protected from increasing federal and state taxes. This can be achieved by moving their money to Roth IRAs. The result - happier, wealthier clients, living the dream of a tax free retirement...thanks to YOU!!


Feature Article
Roth Conversion Planning for 2009 and 2010
Roth IRA Benefits

  • Who can do a Roth IRA Conversion?
    • Roth Conversions for Non-spouse Beneficiaries of Employer Plans
    • 2009 Roth IRA Conversions for Seniors
    • Roth Conversions When a Trust is the IRA Beneficiary
    • Roth IRA Conversions for Younger People are a Must
  • Conversion Rules for 2009
  • Conversion Rules for 2010 and Beyond
  • Deferring Taxes on 2010 Conversions
  • Partial Conversions
  • The Pro-Rata Rule
  • Paying the Roth Conversion Taxes
  • The Impact of the Roth Conversion on Income Taxes
  • Recharacterizing the Roth Conversion
  • Convert to Multiple New Roth IRAs – Not Just One
  • Convert in 2009 or 2010?
  • Making the Decision on When to Convert
  • Tax Bracket Strategy
  • The Big Roth IRA Question
  • Advisor Action Plan

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