Roth Reigns: Some Young Workers Taking a Different Path to Retirement Savings

Though usage across all age groups for Roth 401(k)s is growing slowly, a new study reveals that more employers are offering it as a retirement option, and younger workers are eager to sign up.

In the first quarter of 2013, nearly 17 percent of workers under age 30 are picking a Roth 401(k) defined contribution plan when employers offer it, up from about 15 percent last year, according to a study by Wells Fargo Institutional Retirement and Trust.

“We see this as a significant trend that it keeps increasing,” says Laurie Nordquist, director of Wells Fargo Institutional Retirement and Trust. “It’s not nearly that big of a tax bill if you are under 30.”

Overall, 10 percent of the 2 million participants in a select group of defined contribution plans managed by Wells Fargo are choosing to invest through a Roth 401(k) this year, up from 8.9 percent in 2012. Also, 27 percent of employers in the Wells Fargo study now offer the Roth plan, up 5.3 percent from last year.

The big difference between a traditional 401(k) and a Roth 401(k) is taxes. In a traditional plan, participants don’t pay taxes on money they put in, and on investment earnings. Participants pay federal and state income at the tax rate they are at when withdrawing money in retirement.

For Roth 401(k) participants, it’s nearly the opposite. Participants pay taxes at their taxable income rate when they contribute to the plan. Money grows tax free, and as long as they are at least age 59½, withdrawals from the account are tax free.

Nordquist agrees movement is slow, but it is significant that younger workers are seeing the advantage of Roth 401(k) for two reasons. First, because they are just starting their careers, they are more likely to pay lower retirement taxes now and not have to pay a higher rate when they are at the end of their career, withdrawing at a higher tax bracket. Second, they are making a conscious decision to move into a Roth, since no Wells Fargo participant is automatically enrolled in a Roth plan. If automatic enrollment is used, participants are put into a traditional plan.

“Younger workers really understand that if they can pay taxes now, it’s a really nice opportunity for those with a long runway to retirement,” Nordquist says. “This reflects that people are a little more engaged in the tax element. It’s an important part of saving for retirement.”

The American Taxpayer Relief Act of 2012 made it possible for participants to convert all the money in their traditional plan to a Roth, if the plan is offered by the employer. But Vanguard’s report, How America Saves 2013, shows that even though half of employers in the study offer Roth plans, only 4 percent are offering conversions to participants. Of that 4 percent, only a third of participants are taking advantage of the offering.

As employers wait for clearer instructions from the federal government on how to allow conversions, it’s hard for many participants to come up with the tax cash upfront anyway, says Jean Young, senior research analyst at the Vanguard Center for Retirement Research. But, as a means to hedge against what might happen with the tax system in the future, participants should consider holding retirement dollars in traditional and Roth 401(k) plans.

“We have a highly complex tax system,” Young says. “For participants, having to write that [tax] check today, it can be tough.”

Patty Kujawa is a writer based in Milwaukee. Comment below or email editors@workforce.com. Follow Workforce on Twitter at @workforcenews.