Carlina Teteris | Moment | Getty Images
Roth accounts are available in more than 401 (k) plans than ever before. Retirement savers don’t rush into it.
Approximately 75% of employers with a 401 (k) job allowed employees to save money in a Roth account in 2019: 69% the year before and 46% a decade earlier, according to the latest data from the Plan Sponsor Council of America.
Still, the share of investors saving 401 (k) in a Roth account remains stubbornly low.
About a quarter of 401 (k) investors do, a share that has been fairly stable in recent years, according to Nevin Adams, head of research at the American Retirement Association, a trading group that includes the Council.
More information on personal finance:
Adjusting the cost of living to Social Security may not increase retiree budgets
Half of the young investors invested their stimulus money
Private foundation, fund advised by donors or both?
A Roth 401 (k) is a type of after-tax account. Savers pay taxes on contributions in advance; they do not pay taxes on contributions or income from the investment when they withdraw retired funds.
This is different from traditional pre-tax savings, for which savers receive a tax disadvantage but pay later. Workers can contribute up to $ 19,500 to this year’s 401 (k) between the two account types. (Those over 50 can save an additional $ 6,500).
“We’ve found Roth to be so underused,” said Ellen Lander, director and founder of Renaissance Benefit Advisors Group, based in Pearl River, New York. “It’s amazing to me how much misunderstanding there is.”
Benefits of Roth
Roth 401 (k) contributions make sense for investors who are likely to be in a lower tax bracket than when they retire. (They would accumulate a larger nest egg by paying taxes now at lower rates).
Of course, it is impossible to know what types of taxes or what the exact financial situation of retirement will be, which could be decades in the future.
However, there are some guiding principles. For example, Roth accounts will generally make sense for young people, especially those who have just joined the workforce, who are likely to have the highest-earning years ahead of them.
“It may be the best decision they make,” Lander said. “If you have the ability to make up your money for 20 to 30 years without taxes, that’s great.”
Some may shy away from a Roth because they assume that their expenses (and therefore their tax bracket) will fall when they retire. But that doesn’t always happen, according to financial advisors.
And there are benefits to Roth accounts beyond tax savings.
On the one hand, savers do not have to take the required minimum distributions from Roth accounts, unlike 401 (k) accounts before traditional taxes. Savers can also reduce Medicare Part B premiums, which are based on taxable retirement income; Roth accounts, which produce 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 taxes and Roth, regardless of age, as coverage. Approximately 70% of 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 our investments.
“We should diversify our fiscal strategy.”
Road blocks
Despite the benefits, there are several reasons why people may not make contributions to Roth.
Automatic enrollment has become a popular feature of 401 (k) plans; about 60% of plans use it. Often, companies do not define Roth savings as the default option, which means employees should proactively change their assignment.
“Where is all the new money going?” Adamas said, referring to automatic registration. “Everything happens by default.
“According to the tax treatment, it’s going into pre-tax.”
In addition, employers who match the 401 (k) savings do so in the pre-tax savings box.
Employees may simply not be aware of the Roth option; if they are, inertia can be an obstacle to action.
Higher wage earners may mistakenly think that there are income limits to contribute to a Roth 401 (k), as there is with an individual Roth retirement account. But this is not the case.
Others doubt it because they believe Congress will change tax rules in the future and split into already imposed Roth funds, Adams said.
“They are afraid the government will change its mind,” he said. “I think it ‘s a remote concern.
“But people are constantly worried.”