Roth 401(k) Catching On with Younger Workers. Growing numbers of workers — especially younger ones — are contributing to Roth 401(k)s. If you don’t currently offer this option in your 401(k) plan, here are some reasons why you should consider it.
According to an Alight Solutions, 2017 Universe Benchmarks report cited recently in Forbes, 13% of workers saved on a Roth basis in 2016, up from 12% in 2015 and just 8% in 2011. What’s more, 19% of 20- to 29-year-olds took advantage of a Roth option in 2016, compared to 7% of workers over 60.
And Bank of America Merrill Lynch’s 2017 Plan Wellness Scorecard noted an increase in Roth savings as well. In the 57% of BAML plans with a Roth option, the number of employees who chose it rose by 31% in 2016 from 2015. Of the Roth contributors, over half were under age 40, BAML found.
With more employees showing an obvious interest in contributing on a Roth basis, it’s worth taking a look at your existing 401(k) plan and seeing if offering a Roth option makes sense.
Here are some of the benefits:
Tax-free deferrals and withdrawals: As you know, traditional 401(k) contributions go into a participant’s account tax-free, giving them a tax break at the time of deferral. However, they have to pay taxes on that money when they withdraw it at retirement. A Roth 401(k) allows them to contribute after-tax money and take it out at retirement tax-free. As such, contributing to a Roth is more of a benefit for younger workers with lower wages and lower tax rates, as opposed to deferring money tax-free today and potentially withdrawing it at a higher tax rate in retirement.
In light of that, the Roth 401(k) option is particularly beneficial for those who expect to have a higher combined federal and state income tax rate in retirement. It’s also a boon for those who have the opportunity for tax-free compounding over multiple decades, or for those who plan to leave their Roth savings to their children, who can benefit from the tax-free growth over their lifetimes.
More flexibility for contributions: Roth 401(k) contribution limits are higher than in a traditional 401(k) (in 2017, the 401(k) contribution limit is $18,000; or $24,000 for workers age 50 or older). What’s more, employees can choose all-Roth savings or partial Roth/partial pre-tax.
Tax diversification: Employer matching contributions go in pre-tax, so offering a Roth 401(k) option provides your employees with a tax diversification opportunity in retirement — something they’ll likely appreciate having as part of their benefits package.
No early withdrawal penalties: Since they’re making after-tax contributions to the Roth 401(k), participants can withdraw the money before retirement without having to worry about the typical 10% early withdrawal and tax penalties if they access those savings before age 59 1/2. Great news if they have a financial emergency. Still, it’s important to communicate to employees that they should earmark that money specifically for retirement and leave it where it is so it continues to grow for the future.
As you can see, offering a Roth option can be appealing for several reasons. What’s more, younger employees clearly “get” that making after-tax contributions means fewer tax headaches in retirement. So if your workforce demographic skews younger, or if offering a Roth 401(k) option sounds like it makes sense for your employees, it’s certainly worth a look.
