Roth 401(k): The Tax-Free Retirement Feature Most Investors Overlook

When people think about building retirement wealth, the usual checklist comes to mind: contribute to a 401(k), grab that employer match, and let compounding work over the years. Simple enough. But tucked inside many retirement plans is a feature that could be incredibly powerful — tax-free growth through Roth contributions. The surprising part? Hardly anyone is taking advantage of it.

According to Vanguard’s most recent data, 86% of workplace retirement plans offered a Roth option in 2024, but only 18% of participants with access actually used it. That’s barely a bump from the 17% recorded the year before. Considering how often Roth contributions come up in financial planning conversations, the usage numbers almost look puzzling.

So why are people ignoring it? The answer appears to be part habit, part confusion.

The Basics of Roth 401(k) Contributions

Let’s start with what a Roth 401(k) actually is. Most retirement plans give workers two main choices:

• Traditional (pre-tax) contributions: Your taxable income drops today, and you’ll pay income tax later when you withdraw funds in retirement.
• Roth contributions: You contribute after-tax money, but everything that grows inside the account — and qualified withdrawals later — is entirely tax-free.

Contribution limits for 2025 are fairly generous:

• Up to $23,500 annually.
• A $7,500 catch-up if you’re age 50 or older.
• And for ages 60 to 63, a temporary $11,250 catch-up cap applies.

The difference sounds simple, but the long-term impact can be huge. Traditional accounts also come with required minimum distributions (RMDs), which begin the year after you turn 73. Skip or delay them, and the IRS imposes steep penalties. Roth accounts? No RMDs for the original owner, which makes them far more flexible for retirement income planning.

Why So Few People Use Them

If the Roth is so appealing, why do so few participants choose it? Experts point to one big factor: defaults.

Most retirement plans automatically set employees up with pre-tax contributions. To switch, you’d have to log into the system, change your contribution elections, and possibly read through a wall of HR jargon. And let’s be honest — many people simply don’t revisit those settings after initial enrollment.

There’s also a knowledge gap. The words “after-tax contributions” and “Roth” get thrown around, but they’re not the same thing. Without clear education, it’s easy for employees to shrug and assume the default option is fine. Inertia wins.

Jordan Whitledge, a certified financial planner, put it plainly: “I don’t know that people understand the benefits of the tax-free growth.” And that lack of awareness likely plays a major role in the low adoption.

Who Actually Benefits the Most?

Roth contributions aren’t ideal for everyone, but certain groups stand to gain more:

• Younger workers in lower tax brackets. Paying taxes now while rates are relatively low, then enjoying tax-free withdrawals later, can be a smart long-term play.
• High earners expecting future rate hikes. If you believe your retirement tax rate (or even federal tax rates in general) will be higher down the road, locking in today’s rates is appealing.
• Those with large pre-tax balances. RMDs can create unwanted taxable income later. A Roth reduces that problem.
• Families thinking about heirs. Inherited Roth accounts must still be emptied within 10 years, but withdrawals remain tax-free, sparing beneficiaries from sudden spikes in taxable income.

There’s no single “best candidate,” though. Someone closer to retirement may prefer to hedge with a mix of both Roth and pre-tax. Others might intentionally use Roth contributions in years when their income dips — say during a career change — to take advantage of lower brackets.

The Pre-Tax vs. Roth Debate

Financial advisors often recommend diversification, not an all-or-nothing bet. The right blend depends on your tax picture today and your expectations for tomorrow.

Mike Casey, a CFP and president of American Executive Advisors, explained it this way: “If you expect higher tax rates in retirement, Roth options shine for locking in today’s rates.” But he also noted that many households benefit from a mix — which gives retirees more control over taxable income.

For instance, picture someone in retirement who needs $60,000 for the year. If they only have pre-tax savings, every dollar pulled out adds to taxable income. But if they also have Roth savings, they can draw partly from Roth and partly from traditional accounts, keeping income in a more favorable bracket. That flexibility can reduce taxes not just for one year, but across decades.

Why Participation Might Stay Low

Even with all these benefits, don’t expect Roth adoption to skyrocket overnight. Defaults still shape behavior, and many people prioritize the immediate tax break of pre-tax contributions over long-term planning. Plus, tax rules feel complicated. For someone skimming through HR paperwork, choosing “whatever’s standard” feels easier.

It’s also worth mentioning that not every worker sees Roth as a slam dunk. High earners near retirement may prefer the upfront tax deduction today, especially if they expect lower income later. In that sense, Roth isn’t universally better — it’s just often misunderstood or underappreciated.

A Final Thought

Here’s the takeaway: Roth contributions inside a 401(k) are one of the more underutilized tools in retirement planning. They offer tax-free growth, freedom from RMDs, and greater flexibility in retirement. And yet, fewer than one in five eligible participants are taking advantage.

That disconnect comes down to defaults, confusion, and the very human tendency to stick with what’s easiest. But retirement planning is one of those areas where a little extra effort can make a decades-long difference.

If you have access to a Roth option in your workplace plan, don’t dismiss it out of habit. Take a closer look. Run the numbers. Think about your future tax landscape. It may not be the right fit for everyone, but for many, it’s an opportunity worth seizing.

Disclaimer: The information provided in this blog is for educational and informational purposes only. It does not constitute legal, financial, or professional advice.

Source: cnbc.com