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Roth accounts are available in more 401 (k) plans than ever. Retirement savers are in no rush.
Approximately 75% of employers with a 401 (k) workplace allowed their employees to save money in a Roth account in 2019 – up from 69% the year before and 46% a decade earlier, according to the latest data from the Plan Sponsor Council of America.
Still, the percentage of 401 (k) investors who save on a Roth account remains stubbornly low.
About a quarter of 401 (k) investors do this – a percentage that has remained pretty constant over the past few years, according to Nevin Adams, research director for the American Retirement Association, a trading group that the council is a part of.
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A Roth 401 (k) is a type of after-tax account. Savers pay taxes upfront on contributions; they do not pay taxes on contributions or capital gains when they withdraw funds in retirement.
This is different from traditional pre-tax saving, where savers get a tax break upfront but pay later. Employees can add up to $ 19,500 to their 401 (k) this year between the two account types. (People 50 and older can save an additional $ 6,500.)
“We found that Roth is underused,” said Ellen Lander, director and founder of the Renaissance Benefit Advisors Group, based in Pearl River, New York. “I am amazed how many misunderstandings there are.”
Roth 401 (k) contributions make sense for investors who are now likely to be in a lower tax bracket than they were in retirement. (They would amass a bigger nest egg by paying taxes at lower rates now.)
Of course, it is impossible to know what the tax rates or the exact financial situation will be in retirement, which may be decades in the future.
However, there are some guiding principles. Roth accounts, for example, usually make sense for young people, especially young professionals who are likely to have their highest income years ahead of them.
“It could be the best decision you make,” Lander said. “If you have the opportunity to top up your money tax-free for 20 to 30 years, that’s great.”
Some may avoid a Roth because they expect their expenses – and therefore their tax bracket – to go down when they retire. But that doesn’t always happen, according to financial advisers.
And Roth accounts have benefits that go beyond tax savings.
For one, unlike traditional 401 (k) accounts, savers do not have to make any required minimum pre-tax distributions from Roth accounts. Savers can also reduce their Medicare Part B premiums, which are based on taxable income in retirement; Roth accounts that generate tax-free income can help keep income below certain thresholds above which premiums can rise significantly.
Some advisors recommend allocating 401 (k) savings to both pre-tax and Roth as protection regardless of age. About 70% of the 401 (k) plans allow both, according to the Plan Sponsor Council of America.
“It’s not just about taxes, it’s about flexibility,” Lander said. “We have been taught to diversify investments.
“We should diversify our tax strategy.”
Despite the benefits, there are several reasons why people cannot make Roth contributions.
Auto-enrollment has become a popular feature of 401 (k) plans – around 60% of plans use it. Often times, companies don’t use Roth savings as a standard option, which means employees would have to proactively change their allocation.
“Where is all the new money going?” Adamas said, referring to the automatic registration. “Everything goes into the standard settings.
“As far as tax treatment is concerned, it goes into input tax.”
In addition, employers who match 401 (k) savings do so in the pre-tax savings group.
Employees may also be unaware of the Roth option; If so, indolence can be a stumbling block to action.
Higher earners may mistakenly believe that there are income limits to contribute to a Roth 401 (k), as there is with a Roth Individual Retirement Account. But that is not the case.
Others hesitate because they believe Congress will change tax rules in the future and double-dip into already taxed Roth funds, Adams said.
“They are afraid that the government will change their mind,” he said. “I think this is a distant concern.
“But people are very worried all the time.”