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Using Roth 401(k)s to ‘Supersize’ Retirement Savings: Ed Slott

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While more and more young workers are attracted to the benefits of Roth IRAs, they should also be embracing Roth 401(k)s — “supersized” Roths that allow workers to save more, says IRA expert Ed Slott.

Just-released research by the Investment Company Institute providing updated analysis on investors in traditional and Roth IRAs found that traditional IRAs tend to be opened with rollovers, whereas Roth IRAs tend to be opened with contributions.

The reports — “The IRA Investor Profile: Traditional IRA Investors’ Activity, 2007–2014” and “The IRA Investor Profile: Roth IRA Investors’ Activity, 2007–2014,” which both use data from ICI’s IRA Investor Database — also found that withdrawal activity is lower, equity holdings are higher, and investors tend to be younger in Roth IRAs than in traditional IRAs.

Unlike a Roth IRA, the Roth 401(k), which was made permanent under the Pension Protection Act of 2006, has no income limit and the plans are “picking up steam every year as more people get to know about them” and more employers start offering them, Slott of told ThinkAdvisor in a Thursday interview.

“High earners are not excluded like they would be from a Roth IRA,” Slott says.

The annual contribution limits for the Roth 401(k) are $18,000 or $24,000 if age 50 or older, compared with $5,500 or $6,500 for a Roth IRA.

Slott notes the importance of advisors’ understanding IRAs, particularly in light of the Department of Labor’s fiduciary rule. “Most advisors are not prepared for these [DOL] rules because they don’t have the knowledge. Advisors are going to have to step it up,” Slott says. “The ones who aren’t educated aren’t going to make it. Educated means you have to understand the tax rules; that’s where the clients will lose most of their money.”

Advisors, he stresses, must “step up their IRA education because that’s where all the money is flowing.”

Vanguard’s 2016 How America Saves study found that as of year-end 2015, the Roth 401(k) had been adopted by 60% of Vanguard plans and 15% of participants within these plans had elected the option. Vanguard said that it anticipated “steady growth” in use of Roth 401(k)s due to the tax diversification benefits.

In a Roth IRA, the income “phase-out limits” for contributing are $117,000 to $132,000 for those who are single.

“That means that if income is under $117,000 you can contribute the full $5,500 to a Roth IRA ($6,500, if age 50 or over),” Slott says.

But if a person’s income is between “the limits (in the phase-out range – between $117,000 and $132,000) then the amount you can contribute is phased out proportionately, and if your total income exceeds the $132,000 limit, then you cannot contribute at all to a Roth IRA,” he says. “You are phased out.”

For married taxpayers filing jointly, the Roth IRA limit phase-out range is $184,000 to $194,000.

If the couple’s income is less than $184,000 they can each can contribute the full $5,500 to a Roth IRA ($6,500, if age 50 or older), Slott explains.

“Policymakers created Roth IRAs to give workers another choice for their retirement saving needs,” says Sarah Holden, ICI’s senior director of retirement and investor research. “The data indicate that Roth IRAs tend to be opened with contributions.”

In 2014, nearly three-quarters of new Roth IRAs were opened only with contributions, the ICI research found.

“Many younger workers, being early in their careers and more likely to be in lower income tax brackets, may find Roth IRA investing attractive,” Holden adds.

Indeed, 44% of contributors to Roth IRAs in tax year 2014 were younger than 40, the ICI research found, compared with 15% of traditional IRA investors. Only 24% of Roth IRA investors were 60 or older, compared with 39% of traditional IRA investors.

Traditional IRAs, however, tend to be opened with rollovers. “Because you have to have worked at least some time to generate a rollover, in tax year 2014, about half of traditional IRA rollovers were made by individuals age 45 to 64,” Holden said.

— Check out For IRA Investors, a Warning on DOL Fiduciary Rule on ThinkAdvisor.


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