Reuters Money

Roth retirement accounts are most popular with young investors, but 61-year-old Dallas Salisbury opened one right away when a Roth option was added to the 401(k) plan at his office.

Salisbury isn’t your typical retirement saver. He’s president of the Employee Benefit Research Institute (EBRI), and one of the nation’s top experts on retirement benefits. “I signed up myself as soon as possible and suggested to everyone who works here that they consider a Roth.”

Roth IRAs have been around since 1998. But companies didn’t start offering Roth 401(k)s until Congress eliminated sunset provisions on the accounts via the Pension Protection Act of 2006.

Unlike tax-deferrred accounts, retirement savers use Roths to avoid taxes on investment income down the road by paying income taxes upfront. They’re great for people in lower tax brackets, and for wealthy individuals who want to sock away as much as they can now.

Roth 401(k)s got off to a slow start, but now they’re on a roll. Hewitt Associates reports that 29 percent of mid-size and large employers now offer a Roth option in their retirement plans, and many more plan to add them soon.

“Workplace Roths will become standard over the next few years,” says Pam Hess, director of retirement research at Hewitt. “About half of plans will have them by end of 2011, and it will continue to grow from there.”

A Roth 401(k) offers two compelling advantages over a standard Roth IRA.

You can contribute more. The annual limit on a Roth IRA is $5,000, but a workplace Roth is governed by the 401(k) limits — this year, it’s $16,500.

You can capture a match. The workplace Roth can be used to generate any matching contribution that might be available from employer — although any matching contributions must go into your tax-deferred account. (Employers cut back on matching contributions sharply in the wake of the 2008 crash, although some have restored them.)

This week, President Obama signed into law the Small Business Jobs Act, which should heat up the Roth 401(k) market further. The new law includes a provision that vastly expands the opportunity to convert tax-sheltered retirement savings to Roth accounts; previously, rollovers were limited to Roth IRAs, and people younger than age 59 ½ generally could do it only when leaving a job.

All limits on income for Roth conversions were removed this year under separate legislation. “Now, anyone can do a conversion regardless of age,” Salisbury says. “This law makes tens of millions of people, in essence, eligible for conversion without having to quit their job to do it.”

Why does an economic stimulus bill include a provision opening up workplace Roth conversions? It’s there to raise revenue—at least, in theory.

Remember that funds coming out of a Roth count as taxable income in the year of conversion (with the exception of any after-tax dollars included in that amount). This legislation contains tax cuts and credits for small businesses that come with a $12 billion price tag; the Roth provision—along with some other retirement-related provisions–is intended to offset that by raising $6.6 billion in new tax revenue.

Never mind that retirement savers use Roths to avoid taxes down the road. “It’s a bit of a gimmick,” says Kaye Thomas, a tax attorney and author of several books on taxes and investing. “People generally use a Roth when they think it will produce more tax savings overall—you’re putting money in now because you’re looking at 20 or 25 years of tax-free investment earnings, and you’re willing to pay the tax now to eliminate a tax bill later.

“Since the tax savings are outside the window of the federal budget projection, Congress is counting this as a revenue raiser.”

Quips Salisbury: “It’s the equivalent of being happy you balanced your budget this year by putting money on your credit card.”

But let’s get back to all those new potential tax avoiders. Who among them should be thinking seriously about shifting over to a Roth 401(k)?

Power savers. Unlike a tax-deferred account, a Roth 401(k) allows you to max out your contribution and pay taxes with additional dollars. “The driving reason is that I can put in more upfront because the tax I’m paying doesn’t come out of the balance I’m depositing,” says Dan Rosner, 40, a vice president working in project management at Citi. Rosner switched over to his employer’s Roth option as soon as it was offered in early 2008. “Since the taxes don’t come out of the principal [or investment income], it feels like I’m putting in more money.”

Young savers. Roths are favorable for young workers with lower incomes. “If you’re still in a 10 or 15 percent tax bracket, it’s a good time to use a Roth, as opposed to your forties or fifties, when you may have pushed yourself up the tax scale,” says Salisbury. Hewitt found the highest rate of workplace Roth adoption (16.6 percent) among workers age 20-29–a rate that should go much higher, since Roths are such a home run for young retirement savers.

Tax pessimists. If you think our soaring federal debt must lead to higher income rates, it makes sense to pay the tax bill now.

Roths make less sense for anyone close to retirement age who expects a sizeable drop in income—and tax bracket.

When will you be able to take advantage of workplace Roth conversions? The new rules became effective immediately, which means workplace savers could do conversions this year—in theory. But much will depend on how quickly employers move to amend their plans, so the action probably will start to heat up in 2011.

If you do a conversion in 2010, the law allows you to spread your income tax liability to your 2011 and 2012 tax returns if you prefer. That’s a one-time option that Congress provided earlier, when it lifted the income limits on conversions.