Roth Is Not Just a Young Man’s Game

At 26 years old, I often hear about how making Roth after-tax contributions to my retirement plan will aid in my retirement savings.

I have frequently been told how fortunate I am to have multiple decades to accumulate tax-free earnings on my Roth contributions. And I agree. Roth contributions will play a significant role in my retirement savings, and I am fortunate to make Roth contributions at such a young age.

What I do not understand is why Roth is considered to be almost exclusively beneficial for young workers, when those who are midway, or even well into their careers, may benefit as well. I frequently hear mature workers lament about how they missed out on Roth contributions. Since Roth contributions only became available at a time when they were in a high tax bracket, they decided Roth cannot benefit them. Once, when advising a client to add a Roth option to her firm’s 401(k) plan, she said, “Most of our employees are older than 45. Roth wouldn’t help them.” I disagree.

For example, a $10,000 Roth contribution made by a 50-year-old taxed at 35% will generate $3,500 in taxes today. Assume that the contribution grows at 5% each year for 20 years, up to $26,532.98, and the individual is now in a 20% tax bracket. If the contribution had been made on a pre-tax basis, this individual would pay $5,306.60 in taxes at the time of distribution. The individual would realize an overall tax savings of $1,806.60 by instead making a Roth contribution at 50. Even with a significantly lower tax bracket, Roth contributions would produce overall tax savings.

The math gets even more favorable if we consider Roth contributions growing through retirement instead of just to retirement. Using the previous example, assume the 50-year-old did not touch the $10,000 contribution until age 80 and that they were in the same 20% tax bracket. Growing at an average of 5% for 30 years, this contribution would now be worth $43,219.42. Had the contribution been made on a pre-tax basis, this individual would pay $8,643.88 in taxes at age 80. If they made Roth contributions, they would realize $5,143.88 in tax savings by paying 35% in taxes at age 50.

In fact, using the same figures as the previous example, it takes only 12 years before paying the 35% tax upfront costs less than paying a 20% tax later. That makes Roth contributions beneficial to a far more wide-reaching group than those who are lucky enough to have several decades until retirement.

There is also a common misunderstanding about who qualifies to make Roth contributions in a 401(k) plan. Many individuals believe that if they are not able to make Roth IRA contributions, they are also not able to make Roth 401(k) or 403(b) contributions. That’s not accurate. In 2020, anyone younger than 50 can make up to $19,500 in Roth contributions to a 401(k) or 403(b) plan, and those older than 50 can contribute up to $26,000.

A devastating reality once hit a client of mine when I confirmed that he was eligible to make Roth contributions—including catch-up contributions—into his 401(k) plan. “I wish I would have known” he said quietly. As part of his 401(k) plan, he had invested $100,000 in a lucrative investment which appreciated significantly in 10 years. Had the initial investment been made using Roth contributions instead of pre-tax contributions, the property he sold for more than $700,000 would have been tax free.

This is an extreme example that shows the need for each individual to consider whether their retirement plan contributions should be made as pre-tax or Roth contributions. There is no cutoff age for Roth contributions. Roth contributions may benefit you even if you have been saving longer than some of us new workers have been alive.

Erica K. Johnson is a Qualified 401(k) Administrator and an account manager with BOK Financial. Erica maintains a book of retirement plans, managing all aspects of ERISA compliance, recordkeeping, and investment management for institutional clients.

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services or its affiliates.

About BOK Financial Corporation