When the Economic Growth and Tax Relief Reconciliation Act of 2001 was passed, there was a provision allowing employers to offer their employees the opportunity to make Roth 401(k) deferrals. This provision of the law received little fanfare, since the new provisions applied only in tax years beginning after 2005. Well, 2006 is almost here, and many people are beginning to take notice of this provision in the law -- including the IRS.

Deductible IRAs and regular 401(k) plans work well for those taxpayers who expect their marginal tax rate to decrease during retirement. This means that you're deferring dollars today at a higher marginal rate and then taking those distributions during retirement when your marginal tax rate is less. Therefore, you're gaining a percentage benefit on those future distributions, not to mention the tax deferral of the account while it is in place.

On the other hand, many taxpayers actually expect their marginal tax rate to either remain the same or actually increase during retirement. This isn't as odd as it seems at first blush. It could be that the tax rate increased because of legislative fiat. And it could also be that the taxpayer has fewer itemized deductions during retirement with which to reduce his marginal tax rate. Regardless, there are many folks out there that would certainly fall into this category, even if they don't know it quite yet.

For those taxpayers, the Roth IRA is king. While you don't receive a current deduction for it today, your distributions are tax-free after retirement (assuming certain restrictions are met). And that's just dandy for those taxpayers who assume a higher (or at least the same) marginal tax rate in the future. But the main drawback to the Roth IRA for many people is the fact that contributions can't be made if income is above certain limitations.

But with the advent of the Roth 401(k), this will no longer be the case. Beginning in 2006, a 401(k) plan may allow employees to designate some or all of their elective contributions as Roth contributions. Unlike regular 401(k) contributions, which are excluded from the employee's taxable income, any amount designated as a Roth contribution would be included as taxable income to the employee. But any qualified distribution from designated Roth contributions, and the related earnings thereon, is completely free from federal tax. Also, unlike regular contributions, Roth 401(k) contributions are allowable regardless of your income level. So, for many taxpayers, this could be the only way that they could participate in a Roth account. Sweet.

In order to make this happen, the company that administers the 401(k) plan will have to perform additional accounting. The Roth 401(k), and the associated earnings, will have to be maintained in a separate account from the regular 401(k) monies. Additionally, the administrator will be required to separately allocate, on a reasonable and consistent basis, gains and losses between the designated Roth contribution account and other accounts under the plan. Because of this increased accounting requirement, it's virtually assured that fees to administer these types of plans will increase.

One of the drawbacks to the Roth 401(k) plan is that no employer matching contributions or plan forfeitures can be allocated to the Roth contribution account. That means that the only amounts that will be in the Roth account are the employee's post-tax contributions and the related earnings on those contributions.

Here are some other notes relative to the new Roth 401(k) account:

Section 403(b) Plans are eligible. While the new law specifically refers to 401(k) plans, 403(b) plans are also clearly eligible.

Plans must be amended. Before they can accept Roth contributions, 401(k) and 403(b) plans must be amended to allow for separate tracking of the Roth contributions. Again, this will be an additional expense to the employer.

Plan changes are voluntary for the employer. There is nothing in the law that requires employers to change their 401(k) or 403(b) plans to allow for the Roth contribution. If this is the case with your employer, there is essentially nothing that you can do about it. It simply means that you will not be allowed the benefits of a Roth 401(k) with that employer.

Limited time only. Roth 401(k) plans are scheduled to expire at the end of 2010. Therefore, after 2010, Roth contributions could remain in the plan, but no new Roth contributions could be made after that time. Obviously, Congress could extend these provisions at some time in the future. And that would seem likely should these plans become popular.

So it's not too early to begin discussions with your employer about this plan for 2006. You can see if your employer interested in making the plan amendments. It's likely that the major corporations will be more interested in adding the Roth provision to their 401(k) plans than smaller corporations or businesses. But you'll want to check with your employers to find out where they stand on the Roth 401(k) and how likely it might be that they will make the appropriate adoptions necessary to implement the plan.

Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.