88% of employers offer a Roth 401(k). how to take advantage
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The ranks of employers that offer a Roth savings option to 401(k) investors continue to grow, giving more workers access to its unique financial benefits.
About 88% of 401(k) plans allowed employees to save in a Roth account in 2021, up from 86% in 2020 and 49% in 2011, according to the Plan Sponsor Council of America. The trade group surveyed more than 550 employers in a variety of sizes.
A Roth is a after-tax account type. Workers pay taxes upfront on 401(k) contributions, but investment growth and retirement account withdrawals are tax-free. This differs from traditional pre-tax savings, where workers get a tax break up front but pay later.
Roth acceptance by employees has also grown. Nearly 28% of workers who participate in a 401(k) plan made Roth contributions in 2021, up from 18% in 2016, according to the PSCA. By comparison, 80% of participants made traditional pre-tax contributions. (Workers can choose to use one or both.)
“It’s been going up steadily,” Hattie Greenan, the group’s director of research, previously said of Roth’s growth.
Policy efforts, public awareness fuel use of Roth
Awareness of the benefits of Roth accounts has increased over time among employers and employees, who may be putting pressure on companies to add the option, Greenan said.
Employer education efforts about Roth tax benefits have also likely helped, particularly at smaller companies, where the proportion of 401(k) participants saving in a Roth account rose from 42% in 2020 to 51%. % in 2021, he said.
Public awareness of Roth savings may have grown further in the past year as Democratic lawmakers weighted rules curb the use of such accounts as tax havens for the wealthy. To ProPublica Article described how billionaires like PayPal co-founder Peter Thiel used Roth accounts to amass great wealth.
Ultimately, those Roth restrictions on the wealthy, initially part of the Build Back Better Acta multimillion-dollar package of social and tax reforms, did not make it to the final legislation of the Democrats, the Inflation Reduction Lawwhich President Biden signed into law in August.
Congress is considering adjustments to the Roth rules as part of retirement legislation known as Secure 2.0. One measure would require catch-up contributions (for people age 50 and over) to be made as Roth. Another provision would allow participants choose a Roth option for employer matching contributions.
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However, despite the increasing attention paid to the Roth 401(k), there are many reasons why the overall proportion of 401(k) investors who make Roth contributions remains relatively low.
Auto-enrolling employees in 401(k) plans has become popular: 59% of plans used so-called “auto-enrollment” in 2021. Often, companies do not set Roth savings as the default savings option, which which means that automatically enrolled employees would have to proactively change their assignment.
Additionally, employers that match 401(k) savings do so in the pre-tax savings pool. Higher income earners may also mistakenly think that there are income limits for contributing to a Roth 401(k), as there are with a Roth individual retirement account.
Here’s who can benefit most from a Roth 401(k)
Roth 401(k) contributions make sense for investors who are likely to in a lower tax bracket now than when they retireaccording to financial advisers.
This is because they would accumulate more savings by paying taxes now at a lower tax rate.
It’s impossible to know what your exact tax rates or financial situation will be when you retire, which may be decades from now. “You’re really just making a tax bet,” ted jenkinsa certified financial planner and CEO of oXYGen Financial, recently told CNBC.
However, there are some guiding principles for Roth.
For example, Roth accounts will generally make sense for young people, especially those just entering the workforce, who will likely have their peak-earning years ahead of them. Those contributions and any investment growth would then accumulate tax-free for decades. (One important note: Investment growth is only tax-free for withdrawals after age 59½, and as long as you’ve had the Roth account for at least five years.)
Some may avoid Roth savings because they assume that both their expenses and their tax bracket will fall when they retire. But that doesn’t always happen, according to financial advisers.
Roth accounts also have benefits beyond tax savings.
For example, savers who roll their Roth 401(k) money into a Roth IRA do not need to make the required minimum distributions. The same is not true of traditional pre-tax accounts; retirees must withdraw funds from their accounts on a pre-tax basis starting at age 72, even if they don’t need the money. (Savers with a Roth 401(k) should also take RMDs.)
Roth savings can also help reduce annual Medicare Part B premiums, which are based on taxable income. Because Roth withdrawals are considered tax-free income, strategically withdrawing money from Roth accounts may prevent income from exceeding certain Medicare thresholds.
Some advisers recommend allocating pre-tax and Roth 401(k) savings, regardless of age, as a hedging and diversification strategy.