A Roth option is an investment election available to participants in many employer sponsored retirement plans in the United States (US). Under the federal tax code in the U.S., taxpayers can typically make pension plan contributions on a pre-tax basis. The Roth option enables taxpayers to make contributions with their net, rather than gross, earnings.
Standard pre-tax pension contributions are fully taxable but withdrawals from Roth accounts are exempt from federal income tax. This means that Roth accounts offer tax savings over traditional pensions since the account earnings are never taxed. While employers can make matching contributions on behalf of employees to standard pre-tax accounts, employers are not permitted to make contributions to Roth accounts. If any employee elects to take advantage of the Roth option, any employer made matching contributions are deposited in a separate pre-tax account.
Roth accounts were originally designed as a type of Individual Retirement Arrangement (IRA) into which individuals could deposit a portion of their net income. Unlike employer-sponsored plans, Roth accounts are opened and operated by taxpayers and income restrictions prevent high earners from establishing these accounts. No income restrictions exist on Roth pension plans which means that employer sponsored plans with a Roth option are especially attractive to highly compensated employees.
To prevent individuals from funneling all of their money into tax-free Roth accounts, the Internal Revenue Service (IRS) impose annual contribution limits on these accounts. While these limits change from year to year, the maximum contribution limits on Roth pensions are typically higher than the caps on Roth IRA accounts. Some companies choose not to include a Roth option in company pension plans so as to minimize the administrative costs associated with sponsoring the plan.
Once contributions have been to a Roth pension plan, participants cannot make withdrawals from the plan prior to reaching the national retirement age which is determined by the IRS. Premature withdrawals are subject to a tax penalty as well as regular income tax. Only the account earnings, rather than the participant's contributions, are subject to these taxes. Aside from federal income tax, pension plan participants in many states also have to contend with state income tax. In most instances, state authorities do not tax Roth withdrawals with the exception of premature withdrawals.
Most employer sponsored pension plans include several investment options. Typically, these options include a variety of mutual funds and fixed interest accounts. Investors who elect to take advantage of the Roth option can normally deposit their funds into the same accounts as their counterparts who invest in pre-tax retirement accounts.