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Don’t Ignore the Benefits of Roth 401(k) Contributions

Posted by Brad Bridgewater on Apr 17, 2015 10:00:00 AM
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Southwest Airlines offers pilots a Roth contribution option within the Southwest Airlines Pilots Retirement Savings Plan. Roth contributions are made by plan participants through payroll deductions in the same manner as traditional pre-tax contributions.  Roth contributions are made with after tax dollars and any earnings accumulate on a tax free basis. With Roth contributions, you’re giving up the immediate tax benefit for much greater tax benefits and flexibility in the future.  

Tax-Free Distributions

When you retire and start taking distributions from Roth 401(k) or Roth IRA accounts, those distributions are tax free. Unlike distributions from a 401(k) or traditional IRA, no income or capital gains taxes are due on distributions coming from Roth accounts, so long as the participant is age 59 ½ or older and the account has been in existence for 5 years.  Unlike the 401(k) and traditional IRA accounts, the IRS does not impose minimum required distributions on Roth IRA accounts, so the account owner may leave the money in the Roth IRA well past age 70 ½ if he or she so chooses. It’s important to note that the IRS does impose the age 70 ½ distribution requirement on Roth 401(k) accounts. The way around this is to roll the Roth 401(k) account to a Roth IRA when you retire.

Potential death benefits of Roth 401(k) Contributions

Distributions from Roth IRAs for beneficiaries can get complicated depending on the situation. The first important point to remember is that all Roth IRA accounts have a 5 year holding period before all distributions are free from taxation.  Contributions may be withdrawn at any time because they have already been taxed. If a surviving spouse is the sole beneficiary, he or she may have the account ownership changed to his or her name and treat the Roth IRA as their own.  The surviving spouse would not be subject to any minimum required distribution rules. If the surviving spouse is under age 59.5 and needs to take a distribution, they should roll the money to an Inherited Roth IRA. Upon the death of an original account owner, distributions may be taken by a surviving spouse who is under the age of 59 ½ if the money is first rolled to an inherited Roth IRA. Distribution rules are different for non-spousal beneficiaries. In the case of a non-spousal beneficiary, the individual would need to roll the account to an inherited Roth IRA. Then the beneficiary may elect to liquidate the account by the fifth anniversary of the original owner’s death or they may begin taking distributions by December 31st of the year after the year of the original owner’s death. The distribution amounts will be based on the life expectancy of the beneficiary when distributions begin. If the latter method is chosen keep in mind that a portion of the distribution that represents account earnings may be taxed if the account hasn’t been in place for 5 years. Whenever distributions begin contributions are distributed first, then earnings. So, depending on how long the account has been in place, it’s possible that none of the distribution would be taxed.     

Roth accounts are not considered income

Finally, unlike distributions from 401(k) and traditional IRAs, distributions from Roth accounts are not considered income by the IRS when determining the potential taxation of Social Security benefits. If a retiree’s income is high enough, up to 85% of Social Security benefits may be subject to income taxes.

If you haven’t considered making Roth contributions in the past, you may find that the benefits of Roth contributions outweigh the benefits of traditional pre-tax contributions.  Before making any decisions, you may wish to consult with a financial planning expert to discuss your specific situation.

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Disclaimer: This blog is intended for informational purposes only and should not be construed as individual investment advice. Actual recommendations are provided by RAA following consultation and are custom-tailored to each investor’s unique needs and circumstances. The information contained herein is from sources believed to be accurate and reliable. However, RAA accepts no legal responsibility for any errors or omissions. Investments in stocks, bonds and mutual funds may increase or decrease in value. Past performance is no guarantee of future results. Any of the charts and graphs included in this blog are not recommendations for the purchase and sale of any security. 

Topics: Southwest Airlines Topics