This article will explore the two types of Roth IRA's, the Roth IRA and the Roth 401(k). I will address the similarities and the substantial differences in the two.

The Roth 401(k) plans started in 2006 with the Economic Growth and Tax Relief Reconciliation Act of 2001. They are often referred to as hybrids, meaning they are a cross between the traditional 401(k) plan and the Roth IRA. A Roth 401(k) is an option under the traditional 401(k) plan. So a plan cannot exist with only a Roth 401(k), plans must offer both pre- and after tax contribution options. An after tax contribution is made by designating a portion of your compensation as a Roth 401(k) contribution. You must know that this designation is irrevocable, you will not be able to reassign a Roth 401(k) contribution to have it later treated as a conventional pre-tax contribution.

Roth 401(k) contributions will not reduce your W-2 income. The amount of the contribution will be included in your income and be reported on your W-2 as taxable wages and compensation. The advantage is that earnings can then build up tax free.

Traditional 401(k)s and Roth 401(k)s have many similarities. Both traditional Roth IRA's and the Roth 401(k) have the same contribution limits. Fro 2007, up to $15,500 can be designated as a Roth 401(k) contribution, or if you are 50 or older you can designate up to $20,500 by the end of 2007. The contribution limits are adjusted annually for inflation. You may designate all or part of your contribution to the Roth 401(k). You must decide on how to split these contributions by looking at your tax situation and the advantages of each plan. You should consider the current and the future tax implications of each plan and weigh the current tax cost against the potential tax free income in the future.

Employers are allowed to make contributions , but the actual contributions can only be allocated to the traditional 401(k) accounts. No portion of your employer match may be allocated to the Roth 401(k). Also, funds must be held separately for regular and Roth 401(k) contributions. Investment earnings and charges must be allocated appropriately to each type of account. If you have any plan forfeitures, they can only be allocated to the conventional 401(k); they cannot be allocated to the Roth 401(k).You will have to keep track of each.

You must designate a contribution to the Roth 401(k) before a contribution can be made. Also, under the terms of the plan you must be able to make designations annually.

Allocations to each type of account are non-forfeitable. This means that if you leave a job, you have the option to roll over the Roth 401(k) to an account with a new employer or to roll the funds over to a Roth IRA. A rollover to another Roth 401(k) can be made only via a direct transfer to a new account. The five-year period, discussed more fully below, will carry over to the new Roth 401(k).

If funds should be distributed to you directly, you can be roll over the funds within 60 days to a Roth IRA. They cannot be rolled over to a Roth 401(k) at a new employer because they were distributed directly to you rather than transferred directly to the new Roth 401(k). The five-year period does not carry over from a Roth 401(k) to a Roth IRA; a new five-year period must commence following a rollover to a Roth IRA. Also, once funds have been rolled into a Roth IRA, they cannot be rolled to a Roth 401(k).

Roth 401(k) contributions differ from traditional 401(k) contributions in one obvious way. Roths are made with after-tax dollars, while traditional 401(k) contributions are currently excluded from income. What this means to you is traditional 401(k)s will lower current taxes, while Roths will have no immediate impact on them. However, the earnings on Roth 401(k)s can become fully tax free. Both contributions and earnings in traditional 401(k)s remain fully taxable when distributed.

Roth 401(k)s are similar to Roth IRAs because both are funded with after-tax contributions. There isn't an immediate tax break for putting money into the plan. Roth 401(k)s are also similar to Roth IRAs in the way in which qualified distributions are treated. As with a Roth IRA, funds must be held in a Roth 401(k) for at least five years, then be distributed after age 59-1/2, or on account of disability or death. The first time home buying distribution option for the Roth IRA does not apply to the Roth 401(k).

Roth 401(k)s are different from Roth IRAs in several important ways. These are as follows;

1. Funds from a regular 401(k) cannot be converted to a Roth 401(k), while funds in a traditional IRA can be converted to a Roth IRA. Currently there are income limits on eligibility to convert. Starting in 2010, the income limits are dropped, so you eligible to convert at that time.

2. There is no income limitation on funding a Roth 401(k) as there is for Roth IRAs. In 2007, single taxpayers with modified AGI over $114,000 and joint filers with MAGI over $166,000 are barred from contributing anything to a Roth IRA. Under these circumstances, Roth 401(k)s have the obvious advantage over Roth IRAs.

3. There are required lifetime distributions from Roth 401(k)s; there are no such requirements for Roth IRAs, making Roth IRAs better. Generally, this means that you must start withdrawals from a Roth 401(k) at the age of 70 1/2. If you are still employed at the company maintaining the plan, the plan can allow distributions to commence after retirement if later than age 70-1/2.

Contribution limits are much lower for Roth IRAs than they are for Roth 401(k)s. $15,500 is the top contribution for a Roth 401(k), or if 50 or older by the end of the year, the limit is $20,500. For Roth IRAs, the contribution limit for 2007 is $4,000, or $5,000 for those 50 or older by year end. In this respect, Roth 401(k)s are better than Roth IRAs.

5. Early distributions which are distributions before the end of the five-year period, are treated differently. For Roth IRAs, an early distribution is treated first as relating to nontaxable after-tax contributions. If the distribution exceeds these contributions, the excess becomes taxable. Earnings are considered to be withdrawn last. There is no current tax if a distribution does not exceed contributions to a Roth IRA.For Roth 401(k)s, non-qualified distributions are included in gross income to the extent allocable to income on the contract, and excluded from gross income to the extent allocable to investment in the contract. The amount of a distribution allocated to investment in the contract is determined by applying to the distribution the ratio of the investment in the contract to the designated Roth account balance. If you under age 59-1/2 when the distributions are taken, there is a 10% early distribution penalty, unless an exception to the penalty applies.

So when would it be advisable to use a Roth 401(k)? Here are some factors to consider.

1. If you are younger with a long time until retirement, you may wish to opt for future tax-free income by sacrificing current income deferral. If so, you should choose the Roth over the traditional 401(k). There will be many years in which to build up a sizable retirement fund that produces tax-free income.

2. If you are planning to leave retirement funds to charity, you probably will want to opt for the traditional 401(k). This will give you current tax deferral and no future tax cost. For example, an estate can claim a charitable deduction for funds left to charity.

3. If you are currently in a lower tax bracket, you will not save substantial taxes by opting for current income deferral, and may prefer making Roth 401(k) contributions to the extent possible. In this way, future withdrawals will be tax free when you probably will be in a a higher tax bracket.

This article may not be complete and you should consult an expert about your individual tax situation. However, I have attempted to provide enough information to help educate yourself on the basics. I hope you have found this information helpful.