A growing number of businesses are offering 401(k) accounts, yet the majority of workers aren’t taking advantage of them.

Roth 401(k) plans can be a powerful tool for saving for retirement, but they’re less popular than their conventional counterparts.

A Roth 401(k) plan is similar to a traditional 401(k) plan in that it is provided by an employer and allows for greater maximum contributions than an IRA, or investment retirement account. In 2021, the maximum amount that may be contributed to a Roth 401(k) is $19,500 per year or $26,000 for those 50 and older. Like a conventional 401(k) plan, there are required minimum distributions that must begin by the age of 72 (not to be confused with Roth IRAs, which do not require these withdrawals).

The difference between the two types of 401(k) plans lies in how they are taxed. Traditional 401(k)s are funded with pre-tax funds and the account holder is taxed when he or she withdrawals the money, whereas employees contribute to a Roth account with previously taxed funds that can then be withdrawn tax-free. Roth 401(k) plans are more limited in terms of income than Roth IRAs, with participants subject to income phase-out limitations when contributing to a Roth IRA, but there are no such restrictions on a Roth 401(k).

When workers anticipate that their tax rate will be higher when they retire, they frequently contribute to Roth accounts because the money in these plans grows tax-free and is withdrawn tax-free. Distributions from a Roth IRA are always tax-free, and gains from a Roth IRA are tax- and penalty-free if the account has been open for at least five years and the account holder is 59 1/2 years old.

Roth accounts are not right for everyone. In general, it is considered to be a “tax play.” If your marginal tax rate in retirement is expected to be equal or lower than your current rate, you should not invest in a Roth 401(k). Those who are in lower tax brackets, or are switching careers when their incomes are lower than usual, or business owners who had a terrible year might want to think about it.

It is often difficult to predict future tax brackets, especially if retirement isn’t far in the future and there may be adjustments to wages, as well as tax rules. A good rule of thumb when determining which plan to choose is to compare your current tax bracket against what you think it will be in the future.

Employers have begun to offer Roth 401(k) plans in droves. According to the Plan Sponsor Council of America, about 75% of 401(k) plans now include a Roth option, up from less than 50% a decade ago. These types of investments may gain in popularity, especially if Congress continues to consider changes to Roth conversions.

However, not everyone with access to a Roth 401(k) plan makes use of them. Almost eight out of ten eligible workers made traditional 401(k) contributions in 2019, according to the Plan Sponsor Council of America. Only 26.4% of eligible employees made Roth 401(k) contributions.

It’s important for workers to educate themselves on their retirement options. These days, it seems like everyone has a Roth account but not too many people know how to properly utilize them. Feel free to reach out and let us help you manage your goals. If you would like help creating a customized, comprehensive blueprint to build your financial future from, schedule a no-fee, no-obligation virtual appointment or contact us at (941) 756-8716.  You can also email us at dan@basewealthmanagement.com.