Roth 401(k) A new contribution option available in your 401(k) plan

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1 THE RETIREMENT GROUP AT MERRILL LYNCH Roth 401(k) A new contribution option available in your 401(k) plan Your 401(k) plan is now more flexible than ever! With a choice between the traditional 401(k) and the Roth 401(k) you can decide when your contributions and retirement income are taxed.

2 Your First Considerations Your employer has added a new type of contribution option to give you greater control of your retirement strategy. With the traditional 401(k), your contributions are made using pre-tax compensation so you re not immediately taxed on them. You defer paying taxes until you begin taking distributions, at which time your pre-tax contributions and any earnings are taxed as ordinary income. This type of contribution allows your retirement savings and potential earnings to grow on a tax-deferred basis. With the Roth 401(k), your contributions are made using after-tax compensation after you have paid federal taxes (and any state or local taxes) on your income. At retirement or termination of employment, if you meet the requirements for a qualified distribution, withdrawals of any investment earnings, as well as your after-tax contributions, are tax-free. Contribution Comparison Under your 401(k) plan, you may elect to make both traditional 401(k) and Roth 401(k) contributions. Some plans allow you to make (non-roth) after-tax contributions, and you can always save your after-tax income outside the plan. With the addition of the Roth 401(k), you can decide when you want to pay taxes now or in the future. The chart below introduces you to the Roth 401(k) through a comparison of the various savings options. Savings Options* Traditional Pre-Tax 401(k) Contributions Contributions are deducted from pre-tax pay Current taxable income is reduced Counts toward your annual plan contribution limit Taxes are due on contributions upon distribution unless tax deferral is continued via a rollover Taxes are due on any earnings upon distribution unless tax deferral is continued via a rollover Roth 401(k) Contributions Contributions are deducted from after-tax pay Current taxable income is not reduced Counts toward your annual plan contribution limit Taxes already paid on contributions (none due upon withdrawal) No taxes are due on any earnings if the withdrawal is a qualified distribution Other Savings: In the plan, if available, or outside the plan Contributions are deducted from after-tax pay Current taxable income is not reduced Taxes already paid on contributions (none due upon distribution) Taxes are due on any earnings upon distribution from the plan or a tax-advantaged account outside the plan annually, from a non-tax advantaged account outside the plan * Traditional 401(k) contributions and any earnings are subject to current income tax at distribution (and a 10% tax penalty before age , unless tax deferral is continued or unless an exception to the penalty applies). Roth 401(k) contributions and any earnings are distributed tax-free if received in a qualified distribution; if received in a non-qualified distribution, any earnings may be subject to current ordinary income tax (and a 10% tax penalty before age ). For other savings, any earnings will be subject to taxes as required for the account concerned, e.g., annually for non-tax advantaged accounts, or at distribution and according to prevailing rules for tax-advantaged accounts. 2

3 Choosing a Contribution Type The first and most important consideration is whether or not you expect your tax rate to be lower, the same, or higher when you take distributions from your 401(k) plan. Second, keep in mind that traditional 401(k) contributions are made pre-tax and Roth 401(k) contributions are made after tax; therefore, dollar for dollar Roth contributions will result in less take-home pay. How do you decide which type of contribution may be better for you? Equivalent traditional 401(k) and Roth 401(k) contributions A Roth 401(k) contribution is equivalent to a traditional 401(k) contribution if both would result in the same level of take-home pay under current tax rates, assuming all other factors are equal. For example, assuming a 25% tax bracket, a 4% traditional 401(k) contribution of pre-tax dollars would be equivalent to a 3% Roth 401(k) contribution in after-tax dollars. This table illustrates equivalent traditional 401(k) and Roth 401(k) contributions, based on federal tax rates. Any state or local taxes that apply would increase these differences. Traditional Contribution Percentage 3% 4% 5% 6% 7% 8% 10% 12% 15% Equivalent Roth Contributions at Different Current Income Tax Rates My My My My My tax bracket tax bracket tax bracket tax bracket tax bracket is 15% is 25% is 28% is 33% is 35% 2.6% 2.3% 2.2% 2.0% 2.0% 3.4% 3.0% 2.9% 2.7% 2.6% 4.3% 3.8% 3.6% 3.4% 3.3% 5.1% 4.5% 4.3% 4.0% 3.9% 6.0% 5.3% 5.0% 4.7% 4.6% 6.8% 6.0% 5.8% 5.4% 5.2% 8.5% 7.5% 7.2% 6.7% 6.5% 10.2% 9.0% 8.6% 8.0% 7.8% 12.8% 11.3% 10.8% 10.1% 9.8% Merrill Lynch does not provide tax, accounting or legal advice. Any tax statements contained herein were not intended or written to be used for the purpose of avoiding U.S., federal, state or local tax or tax penalties, and cannot be used for this purpose. Please consult your advisor as to any tax, accounting or legal statements made herein. 3

4 Comparing Final Accumulations: Traditional 401(k) and Roth 401(k) Jennifer: Jennifer Allen currently contributes 6% to her traditional 401(k), which allows her to receive the maximum company matching contribution. She really cannot afford to save more at this time. If she changes to Roth 401(k) contributions, her take-home pay would be reduced. She would need to reduce her contributions below 6% to maintain her current takehome pay. This would cause her to lose part of the valuable employer matching contributions. Sam: Sam Smith wishes to contribute as much as possible toward retirement, even though it is early in his career. He is already able to contribute the maximum allowed to the plan. He intends to work until he is 67, and is interested in the potential tax-free earnings of the Roth 401(k). Their decisions Jennifer can make her decision even without calculating a comparison between traditional and Roth 401(k) results. She chooses to continue making traditional contributions at this time to fully benefit from the match she sticks with her 6% traditional 401(k) contributions. If she is better able to increase her contribution rate in the future, she may switch her contributions to a Roth 401(k). Sam is contributing more than enough to receive the full company match, with either type of contribution. In addition, he expects his tax rate to go up in the future. He uses the Roth 401(k) Comparison Calculator to help him make his decision. Assuming the same investment performance in either type of account, his after-tax accumulation will be somewhat greater with a Roth 401(k). He chooses the Roth 401(k). If you expect your tax rate to be lower when you take distributions, and all other factors are the same, you would expect traditional 401(k) contributions to result in the higher account value at retirement after taxes. If, on the other hand, you expect your tax rate to be higher when you take a distribution, and if all other factors are the same, you would expect Roth 401(k) contributions to result in the higher account value at retirement after taxes. The greater the increase or decrease in your future tax rates, the greater the impact that your choice of contribution type could have on your account value at retirement after taxes. 4

5 Thinking About Future Tax Rates But what about future tax rates? It s hard enough to predict our own personal situation, not to mention what changes government may make to tax rates in the future and how they may affect you. Some people who already have substantial tax-deferred savings may want to hedge their bets on future tax policy and switch to Roth 401(k) contributions so that they have a mix of taxable and Roth 401(k) distributions. Assuming your tax rate remains the same and you realize the same rate of return, if you make tax-equivalent contributions (contributions that would result in the same net take-home pay) to either a traditional 401(k) or Roth 401(k), the after-tax valuations at retirement will be the same. You can try out personal scenarios with the Roth 401(k) Comparison Calculator on Benefits OnLine. Log on to under the 401(k) plan, select Current Elections, then Change Contribution Rate, then Roth 401(k) Comparison Calculator. Keep in mind that you may not want to reduce your contribution percentage if it would result in a loss of valuable employer matching contributions. The Roth 401(k) Comparison Calculator can help you determine which contribution type is right for you. You can model different outcomes by entering different retirement ages or contribution amounts. 5

6 More Facts You Should Know Before You Decide In deciding whether to make traditional 401(k) or Roth 401(k) contributions, your first consideration may be your expectation of your future tax rates. However, there are several other personal considerations. We ve already mentioned one very important one, making sure you take full advantage of your employer s matching contribution, if available. Qualifying for tax-free Roth 401(k) distributions There are two requirements to take a tax-free distribution, otherwise known as a qualified distribution, from a Roth 401(k): At least five years must elapse from the year of your initial contribution, and You must have reached age or become disabled or deceased.* In addition, traditional 401(k) and Roth 401(k) balances are subject to minimum required distributions by April 1 of the year following the year in which you reach age or at retirement, if later. However, with a Roth 401(k) you can roll eligible amounts to a Roth IRA, which is not subject to the lifetime minimum distribution rules. Other distribution requirements may apply after your death. If you take a non-qualified distribution, any investment returns are subject to regular income tax, plus a 10% tax penalty before age Because your contributions are made with after-tax income, they will not be subject to taxes. Keep these requirements in mind if you are planning to take a distribution from your Roth 401(k). How much you can save The combined traditional and Roth 401(k) contribution limit is: Up to an annual maximum of $15,000 in 2006 and $15,500 in 2007 Additional catch-up contributions, if eligible and age 50 or older, of $5,000 in 2006 and also in 2007 *For purposes of qualified distributions, disability must meet the definition stated in Internal Revenue Code Section 72(m)(7). 6

7 Comparing Your Options When you will pay taxes on your contributions When you will pay taxes on any investment earnings Qualified distribution rules* Impact of contributions on take-home pay Rollovers from your account Taxes on employer match, if applicable Required minimum distributions Loan and hardship Traditional 401(k) Contributions Pay taxes in the future You pay the tax upon withdrawal. Contributions are tax-deferred, so current taxes are reduced. You pay taxes on the full amount of any distribution, including earnings, at ordinary income tax rates in effect upon withdrawal. Contributions and any earnings remain in account until age or a separation from service that qualifies for retirement distributions. Withdrawals are subject to current ordinary income tax at withdrawal (and a 10% tax penalty may apply before age ) unless the tax deferral is continued. Since contributions are pre-tax, your current income tax is reduced and each $1 contributed reduces your take-home pay by less than $1. You may roll over your account balance upon termination to a traditional IRA, a 401(k) plan or another qualified employer-sponsored plan. Employer matching contributions are made on a pre-tax basis; contributions and any earnings are taxable upon withdrawal. You must begin required minimum distributions by April 1 of the year following the year in which you reach age or at retirement, if later. Account balances are available for 401(k) loans and hardship withdrawal if the plan allows. Roth 401(k) Contributions Pay taxes now You pay regular income tax on your contributions before the money goes into your account. Current taxes are not reduced. Your contributions have already been taxed, so there is no tax on them and no taxes on any earnings if you take a qualified distribution. Contributions and earnings are distributed tax-free if they meet the requirements of a qualified distribution; earnings in a non-qualified distribution are subject to current ordinary income tax (and a 10% tax penalty may apply before age ) unless the tax deferral is continued. Because you pay current taxes on your contributions, take-home pay is reduced dollar for dollar by your contributions. You may roll over your account balance upon termination to a Roth IRA or another Roth 401(k) or Roth 403(b) account in a qualified employer plan. Note: For purposes of the 5-year rule for qualified distributions, the date of the initial contribution to a Roth IRA governs. Same. The employer match is not treated as a Roth contribution. You must begin required minimum distributions by April 1 of the year following the year in which you reach age or at retirement, if later. Contributions are available for 401(k) loans and hardship withdrawal if the plan allows. *For purposes of qualified distributions, disability must meet the definition stated in Internal Revenue Code Section 72(m)(7). 7

8 Making Your Choice Learn more... Log on to Benefits OnLine to use the interactive Roth 401(k) Comparison Calculator. Together with the information included here, you will see how a Roth 401(k) works in a side-by-side comparison with a traditional 401(k): Log on to Under the 401(k) plan, go to the Current Elections tab. Click on Change Contribution Rate. Put it to work You can elect to make Roth 401(k) contributions online or by phone: Select the Current Elections tab for the 401(k) plan on Benefits OnLine, click on Change Contribution Rate, and enter your election. Questions? Call the Retirement Service Center virtually 24 hours a day, 7 days a week. Click on the Roth 401(k) Comparison Calculator button and enter the required data to complete the comparison. You can find more Roth 401(k) information under the Planning tab on Benefits OnLine. Unless otherwise noted, registered service marks and service marks are the property of Merrill Lynch & Co., Inc. November 2006 Merrill Lynch, Pierce, Fenner & Smith Incorporated Printed in the U.S.A. Member, Securities Investor Protection Corporation (SIPC). 1106