Roth 401(k) plans were legislated into existence by the Economic Growth and Tax Relief Reconciliation Act of 2001. However, they were not set to begin until 1/1/2006 and were given a life span which lasted only through 2010.

The Pension Protection Act of 2006 permanently extended the use of Roth 401(k) plans. Now it becomes more important to understand the advantages and disadvantages of these plans.

Advantages

1. The biggest advantage may be for high income individuals. If you are comparing the Roth 401(k) against a Roth IRA, you will find the Roth IRA has upper income limits. If you are married and file a joint return and your adjusted gross income exceeds $166,000 (for 2007), you cant have a Roth IRA. The Roth 401(k) has no income limits.

2. You can contribute more. For 2007, you can contribute up to $4,000 to a Roth IRA if you are under 50 and up to $5,000 if you are 50 or over. For the under 50 crowd, a Roth 401(k) allows up to $15,500 and for those 50 and older $20,500.

3. If you are over age 50 and still have some "catch-up provision" contributions coming to you, you can put those in the Roth account.

4. If your employer offers the Roth 401(k) option, you can have both. Simply allocate whatever percentage you want into your regular 401(k) and the Roth 401(k) accounts.

5. Roth 401(k) plans can be rolled over to a Roth IRA or to another Roth 401(k) if you switch employers.

6. Withdrawals from the Roth account can be made without paying income tax or the 10% premature penalty if you have had the Roth account for five consecutive tax years and you are at least 59 ½, disabled, or dead (whoever said the IRS doesnt drive a hard bargain?).

Disadvantages

1. Your employer may not want to offer the Roth 401(k) option.

If your existing 401(k) plan provides for a Roth election, the plan has to set up separate accounts and record keeping systems for the Roth contributions. This costs money and may be a deterrent to offering the election.

Many 401(k) plans are "boiler plate" plans, especially those for small employers. I think you will see plan sponsors come up with a simple amendment now the Roth option is permanent. From a bookkeeping point of view, its just a couple of line item alterations. All in all, I would predict the Roth option to gradually become more available.

2. If your 401(k) plan has an employer match, the match must be allocated to the regular 401(k) plan.

Cautions

1. The rules require money remain in a Roth 401(k) or Roth IRA for five consecutive years before it can be taken out without tax. But if you dont have a Roth IRA already set up to receive a roll over from your Roth 401(k), the five year clock starts running when the new Roth IRA receives the rollover.

So if you are within five years of retirement, you need to think about the ramifications of a new five year period starting fresh. The solution is to plan ahead if you can by rolling your Roth 401(k) funds into an existing Roth IRA. When this existing Roth IRA is at least five years old, you can take the money out without paying tax on it.

Failure to plan ahead may not actually be as bad as it seems. Here is the IRS explanation: If you take money out before the five year required time frame, the amount you take out is taxed at a percentage which represents the ratio of the earnings in the account to the total account. So lets say you had $10,000 in your account--$9,400 you put in and $600 of earnings­-and you take out $5,000. Here is the math...

$9,400/$10,000 = 94% x $5,000 = $4,700 not subject to tax. The balance of your $5,000 withdrawal, $300, is taxable.

2. One of the advantages of Roth IRAs is they are not subject to the minimum distribution requirements when you reach age 70 ½. Roth 401(k) plans are treated just like regular 401(k) plans are subject to RMDs. So you will want to roll your Roth 401(k) over to a Roth IRA to circumvent this rule.

Whether or not opting for setting up a Roth account in your 401(k) plan would be to your advantage is a function of a number of factors. You, of course, want to make sure your situation and goals match the rules.

The points advanced here represent my understanding of the Roth 401(k) and in no way are to be taken as tax or investment advice. You need to sit down with your financial planner and accountant, have them run hypothetical calculations of projected after-tax distributions from both types of plans and have a clear understanding of the rules of the game before you can make an informed decision.

Robert D. Cavanaugh, CLU is a 36 year financial and estate planning veteran and author of the free newsletter, "The Estate Preservation Advisor". To subscribe and get the free video, "How to Sell Your Life Insurance Policy for More Than the Cash Value", go to http://theestatepreservationadvisor.com/freevideo.htm