Roth 411

With an official endorsement from the Federal Retirement Thrift Investment Board, Congress is moving -- albeit slowly -- toward approval of spousal accounts and a Roth 401(k) option for the Thrift Savings Plan.

In the legislation, it is referred to as a "Roth contribution program," but Tom Trabucco, the TSP's external affairs director, said it would be closely modeled after the Roth 401(k) available in the private sector.

Unlike a Roth Individual Retirement Account, a Roth 401(k) does not have an income limit, and would be matched by the government with the same formula as the core TSP program.

It likely will be at least a year before the Roth option is available to federal employees. But to help readers prepare for a probable choice between the Roth 401(k) and the traditional TSP offerings, Government Executive talked to several financial planners who advise clients about their options.

What is a Roth 401(k)?

A Roth 401(k) is a retirement savings account, similar to a traditional 401(k) plan, or the TSP for federal employees, but works in reverse.

In the traditional TSP, investors deduct money from their salaries before taxes. The taxes are paid when the money is debited, based on the investor's income bracket at the time of withdrawal.

In a Roth 401(k), an investor deducts money after taxes have been paid. The money is invested in the account and can earn interest tax-free. When the money is withdrawn, the earner pays no income taxes on it.

What are the advantages of a Roth?

For young workers, who typically start out on the low end of the pay scale and have years before retirement, a Roth 401(k) can be an attractive choice. By paying taxes on the investments now, in a lower tax bracket, employees avoid paying larger taxes later, when they likely will be earning more and the account will have grown.

"If you can afford to pay the taxes today, and you're looking at a 20-to-25 year time horizon, more times than not, a Roth 401(k) is a better solution," said Ed O'Connor, managing director of wealth management at UBS.

Some financial planners also recommend a Roth 401(k) for older workers and high-income workers seeking to diversify their portfolios and protect themselves against possible future tax increases.

Aside from the financial benefits, TSP officials tout the plan as a simple, relatively hassle-free way to invest with a low administrative fee.

"Savings, in any form, is a good idea," said William Mason, an Edward Jones financial planner in Olney, Md. "The Roth is just one more option to save."

What are the disadvantages?

A Roth 401(k) essentially is a chance to pay more taxes now to obtain a bigger tax break later. In general, that is a good strategy to follow, advisers say, but it does mean that employees will take home less money in the near-term than they would by investing in a traditional 401(k).

An earner potentially could offset this tradeoff by investing less into the account; although investing less money makes the benefits of a Roth 401(k) over a traditional [retirement plan] 401(k) less obvious.

A Roth 401(k) always will pay off after time, financial planners say. How long it takes depends on the amount of money invested, the worker's tax bracket and other factors. Each case is different, and advisers urge potential investors to consider their individual situations before choosing an investment.

Who should consider a Roth 401(k)?

When the Roth 401(k) option was created, the idea was it would be popular with young workers able to take advantage of the long-term investment benefits.

When the TSP board considered the option, officials said they were thinking service members in particular would benefit greatly from a Roth 401(k).

Federal judges, who have set salaries for life, are another group of government workers who could profit from the plan, along with those with higher salaries looking to diversify their investments.

Aside from those two groups, financial planners disagree about who should consider a Roth. For an individual worker, it can depend on myriad factors, including income, tax bracket, personal budget and retirement age.

Many Web sites have Roth 401(k) calculators that can help employees estimate the costs and benefits of each plan.

Some financial planners advise everyone to weigh the pros and cons of a Roth.

"I would always shoot for the Roth," said Wilma Hayes, a financial adviser with H&R Block and Ameriprise Financial. "It will outperform the traditional in the long run."

If Congress passes the legislation, will the Roth 401(k) option become available to feds? The legislation authorizing the Roth 401(k) plan for federal employees has passed the House, but is still in the Senate, which is not expected to act on the bill before the Memorial Day recess. Because the provision is part of a larger bill -- which also contains a more controversial measure involving a mutual fund window option for feds -- more debate is likely.

Even if the legislation becomes law, it likely will be more than a year before the system is implemented.

Trabucco said the TSP will need to implement a dual system to keep track of the Roth investments and launch a campaign about the program for federal employees. The investment board will be tasked with crafting the Roth 401(k) option, but Trabucco said they want to make it as similar as possible to private sector Roth programs.