Roth 401(k) May Be the Key for Under-40 Workers to Build Wealth

NEW YORK (MainStreet) — Younger and more affluent workers are accessing a wealth-building strategy that has been little-tapped in recent years, but is growing in popularity. The tax-free growth of a Roth 401(k) is now offered by half of employer-sponsored retirement plans, yet only 11% of participants are utilizing the feature.

It's a retirement savings strategy particularly suited to younger workers who believe they will be facing higher tax rates in the future. According to Aon Hewitt's research of 3.5 million eligible participants in over 125 defined contribution plans, over 30% of Roth 401(k) participants are under 40, compared to just under 15% who are over 50. Salary analysis revealed workers earning between $60,000 and $79,000 had the highest Roth participation.

Making after-tax contributions to a Roth 401(k) means never having to pay tax on the savings again, and with a contribution limit of $17,500 this year, it can provide a faster rate of wealth accumulation that a Roth IRA that caps annual contributions at only $5,500. And unlike the IRA version, there is no income limit imposed on Roth 401(k) participation.

"Continued changes to legislation around Roth, coupled with increased awareness and understanding of these plan features, are driving more employers to add a Roth savings feature to their plan," said Rob Austin, director of retirement research at Aon Hewitt. "Because of the potential tax benefits, employees increasingly see Roth accounts as attractive savings options and we anticipate that the use of Roth will continue to rise."

Roth users also save more than other 401(k) participants, deferring wages at an average rate of 10.2%, compared to a contribution rate of 7.7% by other participants. That's a nearly one-third (32%) higher savings rate. And an employer match to a worker's contribution can immediately double at least a portion of the after-tax savings in a Roth 401(k).

"Young workers and mid-level earners are most likely to benefit from investing based on today's tax rate," Austin added. "These workers are more likely to anticipate future tax bracket increases, so they are taking actions now that are likely to benefit them down the line."

As of last year, more than one-quarter (27%) of plans offering a Roth feature also allow in-plan conversions, where participants can convert an existing 401(k) balance to a Roth account. Of course, taxes will be due during the year of conversion for transitioning the assets from before-tax to after-tax – and those taxes cannot be drawn from the defined contribution plan balance.

--Written by Hal M. Bundrick for MainStreet

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