As Roth 401(k) plans continue to spread, young workers increasingly are voting to go Roth. In the first quarter of 2013, 10% of all participants in Wells Fargo-administered defined contribution plans contributed to a Roth 401(k), when available, up from 8.9% a year earlier. Leading the way were employees under age 30: 16.9% chose the Roth route, a jump from 15.2% participation in last years first quarter. (Only 4% of participants in their 60s chose the Roth version this year.)
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.
This is particularly interesting news for financial advisors with young, not-so-wealthy-yet clients, especially those who stand to inherit from high net worth parents. Using a Roth plan wouldnt cost them much in income tax today because they arent earning much but has huge potential benefits as they age and vault into much higher tax brackets due to wealth transfer events. Younger investors also have time on their side: with 40 years until retirement, assets have plenty of time to grow and are distributed, tax-free, after age 59 1/2 (provided the account is at least five years old.
The findings were based on an analysis of two million eligible participants in a subset of retirement plans that Wells Fargo administers.
Data provided by Wells Fargo to On Wall Street show that about 17% of active participants in these defined contribution plans are under 30. As might be expected for those just starting in their careers, 93% have incomes under $60,000. Thirty-three percent of the employees in this age group earn under $20,000, another 44% earn up to $39,000, and 16% have income in the $40,000-$59,000 range. The under-$20,000 representation is high because we have a lot of clients in the retail and restaurant industries, a Wells Fargo spokesperson explained, which means a lot of part-time workers.
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 were 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 can be tax-free, regardless of future income tax rates.