Roth 401(k) An option available to 401(k) participants

Transcription

1 Roth 401(k) An option available to 401(k) participants

2 Dear retirement plan participant, We re pleased to announce that, in our effort to help you better prepare for retirement; you are now able to take advantage of the Roth 401(k). This exciting plan feature may result in additional tax savings for certain plan participants. What is Roth 401(k)? Contributions to your company s qualified retirement plan have generally been tax-favored. That s probably one of the reasons why you participate in the plan. In the case of a traditional 401(k) plan, because your contributions are made on a pre-tax basis, you re not immediately taxed on them. The Roth 401(k) provides an alternative tax benefit to this traditional model. With Roth 401(k), provided that certain conditions are satisfied, you secure the tax benefit when you take money out of the plan. Right now, when you reach retirement and start withdrawing money from the plan, your pre-tax contributions and any earnings will be taxed as ordinary income. With the Roth 401(k) option, you ll be able to withdraw money tax-free if it is a qualified distribution. But there s a trade-off: contributions to Roth 401(k) are after-tax you don t get the tax benefit when you make your contributions. So, you now have three options: traditional 401(k), Roth 401(k), or a combination of both. You probably already have many questions... What exactly is Roth 401(k)? What are the main differences between a traditional 401(k) and a Roth 401(k)? What should I be considering when making my decision? Who will likely benefit from Roth 401(k)? Are there situations where it might not be a good idea? What should I do next? In the following pages, these and many other important questions are addressed in an effort to provide you with the information you need to help you make the decision that is right for you. This is the perfect time to evaluate your overall retirement strategy. To find out how you re doing and make sure your retirement savings strategy is aligned with your goals, visit (if you are a participant in a plan domiciled in New York, visit Use the many web tools and learning resources available to you. And if you feel the Roth 401(k) is a good option for you, simply complete the form at the back of this brochure and you ll be on your way.

3 What is the main difference between a traditional 401(k) and a Roth 401(k)? Helping you decide if Roth 401(k) is a good option for you. Your company offers you the opportunity to participate in, and contribute to, a qualified retirement plan. With the addition of Roth 401(k), there are now three different ways to make these contributions. Your personal situation will help determine the option that is best for you. First, your contributions can be made with pre-tax dollars (traditional 401(k)), giving you the benefit of deferring taxes until your retirement. Another alternative you might want to consider is the Roth 401(k) option. And finally, if your plan allows, your third choice may be to make your contributions by combining the traditional 401(k) and Roth 401(k) options. This guide has been designed with the tools and information to help you understand these options and to help you make the decision that is right for you. What s the main difference between a traditional 401(k) and a Roth 401(k)? With a traditional 401(k), you make pre-tax contributions to your retirement account. That means you don t have to pay income taxes until you withdraw the money (contributions and earnings), typically upon your retirement. With Roth 401(k), you make after-tax contributions to your retirement account. With the Roth 401(k) option, you will be able to make tax-free withdrawals (contributions and earnings) in the future if certain conditions, which we ll describe, are met. The main difference between these choices is that with a traditional 401(k), you pay your taxes later and with a Roth 401(k), you pay your taxes now. When you ve finished reading this guide, you ll be better equipped to choose the option that s best for you, which may include: 1. Contributing to a traditional 401(k) 2. Contributing to a Roth 401(k) OR 3. Contributing to both a traditional 401(k) and a Roth 401(k) This is also a perfect time to make sure your retirement savings strategy is aligned with your retirement goals and to see if you re contributing as much as you can for your future. Here are three simple steps to follow to help determine the right option for you...

4 Step 1: Understand the facts For most participants, the key advantage of Roth 401(k) is tax-free withdrawals. With Roth 401(k), you pay taxes on your contributions now and will have tax-free withdrawals in the future. For this to occur, two conditions must be met: This leads to another important fact. If you want to contribute the maximum amount to a Roth 401(k), you will actually need to save more, because taxes are taken out before the Roth contribution goes into your retirement account. Right now, it s time to compare Roth 401(k) tax-free withdrawals against a traditional 401(k) s potential to reduce your current income taxes. 1. A withdrawal must be a qualified distribution. This means money can be withdrawn from your Roth 401(k) when you are age 59 1 /2 or older, upon disability, or on or after your death. 2. Your Roth 401(k) contributions must remain in the plan for at least five years from the first day of the year of your first Roth 401(k) contribution. If you plan to contribute to a Roth 401(k), the sooner you start contributing, the easier it will be to meet this five-year requirement. With a traditional 401(k), you defer paying taxes until you withdraw the money upon retirement, or a permissible distribution event. In addition, you can also potentially reduce the income taxes you re paying now. That s because your income taxes are calculated based on your salary after your contributions to a traditional 401(k) are deducted. 2

5 This table provides a comparison of the Traditional 401(k), Roth 401(k) and a Roth IRA. Traditional 401(k) Roth 401(k) Roth IRA Contributions Funded with pre-tax dollars Funded with after-tax dollars Funded with after-tax dollars Investment earnings Tax-deferred earnings Tax-free earnings Tax-free earnings if qualified distribution Taxes paid Pay taxes on contributions and earnings later Reduce current income tax Pay taxes on contributions now Qualified withdrawals are tax-free Pay taxes on contributions now Qualified withdrawals are tax-free Maximum 2008 contributions $15,500 ($20,500 if age 50 or older) $15,500 ($20,500 if age 50 or older) If participant makes a combination of Roth 401(k) and pre-tax elective deferrals, the total amount contributed cannot exceed the contribution limit Subject to IRA limits $5,000 ($6,000 if over age 50) Income restrictions No No Yes. The Roth IRA cannot be used if the modified adjusted gross income is $101,000 or more for single filers ($159,000 or more for a married couple filing jointly) Tax-free distribution Not available Two conditions must be met: 1. Distribution must be a qualified distribution attainment of age , death or disability AND 2. Special 5-year rule distribution occurs no earlier than the fifth taxable year after the year of the first Roth 401(k) contribution Two conditions must be met: 1. Distribution must be a qualified distribution attainment of age , death, disability or is a qualified first-time home-buyer distribution AND 2. Special 5 year rule distribution is made after the 5-year period beginning with the first taxable year in which a contribution was made to a Roth IRA Minimun required distribution Yes Yes Minimum distribution requirements apply to distributions made after Roth IRA owner s death Rollovers Can be rolled over into a 401(a), 403(b) or 457(b) plan or a traditional IRA Can be rolled over into another Roth 401(k) account, a Roth 403(b) account, or a Roth IRA Can be rolled over into another Roth IRA Are there other Roth 401(k) benefits? A Roth 401(k) allows you to lock in the tax rate that you re currently paying, so that both your after-tax contributions and earnings can be withdrawn tax-free when you retire. If you expect your income (and your tax rate) to rise in the future, a Roth 401(k) may be an effective way to reduce the taxes you pay. By contributing to both a traditional 401(k) and a Roth 401(k), you may customize your retirement savings and withdrawals based on your life events and tax situation. For example, if your plan permits, a combination of traditional and Roth 401(k) gives you additional choices on the timing of your taxes. In retirement, in years that your income tax rate is higher, you may want to withdraw from your Roth 401(k); in years that your income tax rate is lower, you may want to withdraw from your traditional 401(k). The decision to designate all or part of your elective deferrals as traditional 401(k) or Roth 401(k) will depend upon your personal circumstances. You must weigh the value of tax-free withdrawals at retirement, a key benefit of a Roth 401(k), against the value of reducing your current taxable income with a traditional 401(k) program. 3

6 Step 2: Consider these factors that may impact your decision As we mentioned earlier, participating in the Roth 401(k) program is your individual decision and will ultimately be based on your personal circumstances. Some of the factors that will impact your decision are: Your age Your income Your current tax rate and your expected tax rate when you retire The number of years until you retire Your expected financial needs when you retire Your expected sources of retirement income To see how some of these factors come together, it s helpful to examine some common scenarios involving both a Roth 401(k) and a traditional 401(k). These are hypothetical examples, used for illustrative purposes only. 4

7 Karen Lee Age: 25 Occupation: Associate Investment Analyst Taxable Income: $28,000 Tax bracket: 15% Filing status: Single Situation: Karen finished graduate school last year and started her first job in an investment firm. She is engaged and plans to start a family in a few years. She is confident that she will do well in her career and expects her salary to rise considerably over time. Karen expects to be in a much higher tax bracket by the time she and her husband are ready to stop working in approximately 40 years. Does the Roth 401(k) offer advantages for Karen? Yes, because Karen expects her income to grow, the Roth 401(k) allows her to pay taxes now and avoid taxes on her withdrawals upon retirement. She has an extended time period until retirement, so her earnings can accumulate and be withdrawn tax-free as a qualified distribution. Karen must realize that if she contributes only to the Roth 401(k), she will lose the potential to reduce current income taxes, which is a key benefit of a traditional 401(k). If Karen doesn t want to give this up, yet also finds the Roth 401(k) to be appealing, she may want to contribute to both the traditional and Roth 401(k) options. Will Anderson Age: 40 Occupation: Plant Foreman Taxable income: $51,000 Tax bracket: 25% Filing status: Single Situation: Flexibility is what Will wants most of all. When he retires he wants to be able to choose distributions from pre-tax or after-tax accounts depending on his financial needs and tax status. Does the Roth 401(k) offer advantages for Will? Yes, Will can divide his annual $15,500 contribution into traditional and Roth 401(k) accounts. Will can use the Roth 401(k) account as a hedge against higher taxes in the future. When he retires, if the income tax rate is high, Will can withdraw from his Roth 401(k); if the rate decreases, or he is subject to a lower tax bracket, Will can withdraw from his traditional 401(k) account. Will should check whether his plan permits him to make choices on taking withdrawls from specific money types or allows partial withdrawals. 5

8 Paula Milano Age: 50 Occupation: Software Manager Taxable income: $120,000 Tax bracket: 28% Filing status: Married filing jointly Situation: Paula enjoys her work and plans to continue for many years. She and her husband and two children live in a metropolitan area and though it s expensive, she and her husband are diligently saving for retirement. Paula realizes that to maintain her current lifestyle in retirement, she needs to save as much as she can now. She knows that most experts estimate that people need between 60-80% of their annual income in retirement. This leads to Paula s primary concern taxes on distributions from her 401(k) plan, coupled with the belief that rising tax rates might erode the value of her retirement savings. There may be less money for her retirement years and even less to pass on to her children. She finds the Roth 401(k) appealing because it appears to match her retirement and estate planning strategy. She is not concerned about giving up the benefit of contributing to a traditional 401(k) with pre-tax dollars. Does the Roth 401(k) offer advantages for Paula? Yes. By contributing to the Roth 401(k), Paula can pay taxes now and avoid taxes later. When Paula retires, she can also avoid the Roth 401(k) minimum required distribution rule at age 70 1 /2 by rolling it into the Roth IRA. Joe Barnes Age: 45 Occupation: Retail Manager Taxable income: $60,000 Tax bracket: 25% Filing status: Married filing jointly Situation: When Joe retires at age 60, he doesn t expect to be in a higher tax bracket. On the contrary, he expects to be in a lower one. Joe and his wife plan to downsize their house and simplify their life. From Joe s perspective, he will be home free. Joe doesn t expect his income to significantly rise over the next 20 years. He knows he is earning near the top of the pay scale for his position and he is not interested in changing companies. When it comes to tax issues, Joe isn t worried that his taxes will significantly rise during his retirement years. Even if they do, he plans to be in a lower tax bracket and feels confident that the taxes he will owe on his 401(k) withdrawals will not be a financial burden. Does the Roth 401(k) offer advantages for Joe? Probably not. Because Joe expects to be in a lower tax bracket, there may be little advantage for Joe to make Roth 401(k) contributions. The only possibility is if Joe seeks to lower taxes on his Social Security benefits, the Roth 401(k) s withdrawals will be excluded as taxable income when calculating taxes from Social Security payments. This is because the Roth 401(k) withdrawals or qualified distributions are tax-free, as taxes have already been deducted when the original contributions were made. 6

9 Step 3: Make the decision You re making great progress. As you prepare to make your decision on whether to contribute to the Roth 401(k), a traditional 401(k), or both, there are a few final items to consider. In the case of Roth 401(k) contributions, if you make a partial withdrawal, the distribution will be pro-rated between contribution and earnings, the earnings will be taxed. If you make a total withdrawal, the earnings will be taxed. And if you are under age 59 1 /2, your earnings will be subject to a 10% penalty tax. Don t put off taking action If you think that you could benefit from the features of the Roth 401(k), remember that in order to receive tax-free withdrawals, your Roth 401(k) contribution must remain in the plan for five years and satisfy the requirements in the chart on page 3. The five-year clock* begins with the first day of the first year of your Roth 401(k) contribution. If your employer makes matching contributions to your Roth 401(k): these contributions will always be with pre-tax dollars and you will owe taxes on the contributions and earnings upon retirement. Your employer s matching dollars will be held in a separate account, apart from Roth 401(k) contributions. If you decide to contribute to the Roth 401(k): once your contributions have been designated as Roth 401(k), what has already been contributed cannot be changed back to a traditional 401(k). However, your plan will specify how frequently you can change your elective deferral designation, so that you are not locked into making Roth 401(k) contributions in the event you change your mind in the future. If you want to take a non-qualified distribution: Depending upon your plan s features, you may be able to withdraw your contributions and earnings in situations of financial hardship. In the case of a traditional 401(k), once you withdraw from your account, the contributions and earnings will be taxed. Additionally, if you are under age 59 1 /2, you will be subject to a 10% penalty tax. As an alternative, many qualified retirement plans offer participants the opportunity to take a loan against their contributions. Check with your plan administrator for details. The Pension Protection Act of 2006 repealed the 2010 Sunset provisions for Roth 401(k) (and other EGTRRA provisions), and rendered these provisions permanent. If you make the decision to directly roll over the Roth 401(k) from a previous plan into your retirement plan account at John Hancock, the five-year clock* will continue from the year you first contributed to the Roth 401(k) with the previous provider. *Special rules may apply to the determination of the 5 taxable year period of participation. Contact your plan administrator or your financial tax advisor to find out if they apply to you or for specific details on the 5 taxable year period of participation. 7

10 Congratulations! You re taking an active role in shaping your retirement future. Contact your tax consultant for advice regarding your specific tax situation and goals. For additional information, visit (if you are a participant in a plan domiciled in New York, visit Review our About Roth 401(k) Accounts where you ll find more Roth 401(k) topics, frequently asked questions, the Roth 401(k) calculator and much more. In addition, you have the ability to: Manage your account: access your account balance and performance information Make changes to your account and rebalance your portfolio Consider what you have just accomplished. You ve learned about the key differences between the traditional 401(k) and Roth 401(k) and now have the basic information you need to decide which option is best for you: 1. Contributing to a traditional 401(k) 2. Contributing to a Roth 401(k) OR 3. Contributing to both a traditional 401(k) and a Roth 401(k) Learn more about projected retirement income: see it in today s dollars Empower yourself with information: use our Retirement calculators, take the Risk Quiz, and learn from our personal finance topics 8

11 Roth 401(k) An option available to 401(k) participants This document does not constitute legal or tax advice with respect to any taxpayer other than John Hancock Financial Services, Inc. and its affiliates. It was neither written nor intended for use by any such taxpayer for the purpose of avoiding penalties, and it cannot be so used. If it is used or referred to in promoting, marketing, or recommending any transaction or matter addressed herein, it should be understood as having been written to support such promotion, marketing, or recommendation, and any taxpayer receiving it should seek advice based on the taxpayer s particular circumstances from an independent tax advisor. In this document, all tax disclosures regarding Roth 401(k) contributions are limited to the federal income tax code and in particular, all references to tax-free treatment of qualified distributions are intended to refer to the treatment of such distributions a the federal level only. Both John Hancock Life Insurance Company (U.S.A.) and John Hancock Life Insurance Company of New York do business under certain instances using the John Hancock Retirement Plan Services name. Group annuity contracts are issued by John Hancock Life Insurance Company (U.S.A.), 601 Congress Street, Boston, MA 02116, which is licensed and offers products in all states, except New York. Product features and availability may differ by state. Group annuity contracts and administrative services or record keeping agreements issued in New York are only issued by John Hancock Life Insurance Company of New York, 100 Summit Lake Drive, Valhalla, New York 10595, which is licensed in New York. NOT FDIC INSURED MAY LOSE VALUE NOT BANK GUARANTEED NOT INSURED BY ANY GOVERNMENT AGENCY 2007 John Hancock. All rights reserved. P GE 11/ GA Contribution Change Form If you would like to change your contribution to your plan, complete this card, detach it and give it to your plan contact. They will let you know when the change in payroll will take effect. Name (last name, first name, initial) Social Security Number Salary deferral information below is solely for the benefit of the plan administrator. This information shall not be maintained or acted upon by John Hancock. Please report any change to this information directly to the plan administrator at your company. Each deferred amount below and the combined total amount of your deferral are not to exceed current plan, state and / or IRS limitations and regulations. Now check the boxes below as appropriate I elect to defer: Traditional 401(k) % or $ from my salary / wages per pay period as ongoing contributions. and/or Roth 401(k) % or $ from my salary / wages per pay period as ongoing contributions. Signature Date Roth 401(k) deferrals will be allocated in the same manner as your traditional 401(k) deferrals. If you have not previously deferred any amounts under a John Hancock group annuity contract, you must complete Section C (allocation instructions) of the New Participant Enrollment form. If these instructions are not completed, your deferrals will be allocated to a default Fund. Contact your plan sponsor to obtain a New Participant Enrollment form John Hancock. All rights reserved. P GE 11/