Financial advisors with young, not-so-wealthy-yet clients should consider steering them toward a Roth 401(k), if they aren’t already headed there themselves.
Many of them are, according to data provided by Wells Fargo to On Wall Street, which shows that the Roth defined contribution plans are gaining in popularity in general and with young workers in particular.
“The continued upswing of Roth usage is driven by younger investors,” Laurie Nordquist, director of Wells Fargo Retirement, said in a statement. “This suggests that they are aware that their tax rates will likely go up as they age. Therefore it is a good strategy to opt for the lower tax bracket now, versus waiting to be taxed at their unknown rates in their 60s.”
“The new rules for converting existing traditional 401(k) assets to after-tax Roth 401(k) assets may have heightened awareness of how Roth plans work,” Nordquist stated, “which could be playing a role in the trends we’re seeing.”
Under the tax law passed at the beginning of this year, employees can convert all or part of their traditional 401(k) balance to a Roth 401(k) at any time, as long as their employer offers both versions and the plan documents permit such conversions. Taxes are due on these conversions, but the ultimate payout—including accumulated interest and capital gains—are tax-free after age 59 and-a-half, regardless of future income tax rates, provided the account is at least five years old.
Contributions to a Roth plan won’t cost younger workers much in income tax today, because they aren’t earning much to begin with. But it has huge potential benefits as they age, increase their earnings and enter into much higher tax brackets in the process. Younger investors also have time on their side: with 40 years until retirement, their assets have plenty of time to grow.