Traditional 401(k) contributions are excluded from an employee's taxable income in the year they are made but the account balance, including earnings, is taxed as ordinary income when it is distributed.

On the other hand, Roth 401(k) contributions are not excluded from an employee's taxable income when they are made. However, distributions of these contributions, along with their investment income, are tax free.

How does a Roth 401(k) differ from a Roth IRA?

There is no income threshold for a Roth 401(k) — all participants can contribute regardless of how much money they make. An individual can contribute to a Roth IRA only if his or her income does not exceed a threshold amount.

An individual can contribute up to $4,000 to a Roth IRA in 2005 (subject to the income threshold rules). This amount will increase to $5,000 in 2008 and will be adjusted for cost-of-living increases thereafter. If the individual is age 50 or older in 2005, he or she can make an additional $500 "catch up" contribution. This amount will increase to $1,000 in 2006.

In a Roth 401(k), the contribution limits are significantly higher: up to $15,000 in 2006 plus an additional $5,000 for those age 50 or older. These amounts will be adjusted for cost-of-living increases beginning in 2007.

What other requirements will a plan have to meet?

Roth 401(k) contributions must be combined with pre-tax 401(k) contributions for purposes of the actual deferral percentage (ADP) test.

The combined Roth 401(k) and pre-tax 401(k) contributions for any individual cannot exceed the annual maximum ($15,500 in 2007 plus an additional $5,000 catch up contribution for individuals age 50 and older.)

Employers will be able to make matching contributions with respect to both Roth and traditional 401(k) contributions. Matching contributions are treated the same as under current law regardless of whether they are based on Roth or traditional 401(k) contributions.