The first day of 2018 will have special meaning for some retirement planners — the 20th anniversary of the Roth IRA.
The plans, which allow individuals to contribute after-tax money into an account that they can withdraw from tax-free in retirement, were first proposed by Sen. Bob Packwood of Oregon and Sen. William Roth of Delaware in 1989, but weren't available until the Taxpayer Relief Act of 1997.
Since then, Congress has gradually loosened rules on Roth IRA contributions, and the accounts are now owned by 21.9 million households. Growth has been faster than traditional IRAs, which are owned by 35 million households since launching in 1974.
They have been especially popular among young investors. A third of Roth IRAs are held by investors under the age of 40,
according to a report by the Investment Company Institute.
YOUNG INVESTORS
Nick Holeman, a certified financial planner at Betterment for Business, the digital adviser's division that provides small businesses with automated retirement plans, said Roth IRAs are attractive to the market of younger, smaller investors that robo advisers tend to attract.
(More: Betterment retirement robo attracts 300 companies to 401(k) platform)
"The reasoning is there are so many variables that go into retirement planning that we just cannot plan for," Mr. Holeman said, citing market returns, inflation, life expectancy and living expenses. These factors can be especially difficult to predict for someone several decades away from retirement, but Roth IRAs and 401(k)s take one factor off the table — taxes.
With fewer variables, it's easier to create a more concrete financial plan.
"The assumption is when you're young, your income can be okay and you plan for income to increase over time," Mr. Holeman said. "Paying taxes now can be very beneficial."
CONTRIBUTIONS
The majority of new Roth IRAs are opened by contributions rather than conversions from traditional IRAs or 401(k) rollovers. Ed Slott, a CPA and founder of Elite IRA Advisor Group, believes that is preventing IRA growth from what it should be.
The primary reason is the tax bill investors face when making the contribution, but Mr. Slott said this is preventing many investors, especially the high-net-worth clients of financial advisers, from realizing huge long-term benefits.
"All of this money will never be taxed again," Mr. Slott said. While they aren't appropriate for everyone, he thinks retirement savers are almost always better off with a Roth account. "They are losing bigger revenue in the future."
Mr. Holeman said Roth retirement plans will continue to grow in popularity as more investors are made aware of them, and that it is one the most common questions he gets from clients.
Though the new tax bill abolishes Roth IRA recharacterizations, which allowed
Roth IRA conversions to be partially or fully undone, Mr. Holeman doesn't think it will slow the popularity of these accounts.
NEW OPPORTUNITY
Mr. Slott said the tax bill presents an opportunity for advisers with Roth IRAs. Investors should be more careful with the decision to convert to a Roth IRA, and will need professional advice more than ever.
(More: Your tax bill questions answered)
"Advisers are so well-positioned to capitalize on that money sitting in IRAs just waiting to be converted into tax-free Roths," Mr. Slott said.
He added that the new bill,
signed into law by President Donald J. Trump last week, proves that Congress seeks the immediate tax revenue brought in by Roth retirement accounts as a way to plug budget gaps. For this reason, he said, "Roth is the way of the future."
Mr. Slott believes the effects of Roth IRAs on the retirement industry will be even more profound over the next 20 years, as early adopters retire tax-free.
"Now that is a great retirement, compared with people who retire with 401(k)s and IRAs," Mr. Slott said.
