Roths Are All the Rage as Savings Rates Reach a Record High

Average 401(k) balances fell in the first quarter, but savings rates reached a record 14.4% and strong demand for Roth accounts sent IRA contributions to a record high, according to analysis released by retirement plan recordkeeper Fidelity Investments on Thursday.

The market rout that unfolded at the end of March sent average 401(k) and IRA balances down 4% at Fidelity, leaving them at $141,000 and $131,380 respectively. The ranks of 401(k) millionaires also suffered, with the tally down 3% from the prior quarter.

At the same time, the average employee contribution rate hit 9.6% — the highest ever. That, combined with an average employer contribution rate of 4.8%, is close to the 15% savings rate Fidelity recommends. Many 401(k) plans now automatically bump up employee contributions by 1% a year unless participants opt out of the feature.

“Retirement savers started the year strong with record-high savings rates and contributions, reflecting the long-term approach they’re taking with retirement preparedness,” said Sharon Brovelli, president of workplace investing at Fidelity Investments, in a press statement.

The most notable action was in the use of Roth accounts. Roths are funded with after-tax money that can then compound tax-free in the account. As long as a Roth has been open for at least five years, the earnings and original contributions can be withdrawn tax-free in retirement. Unlike with 401(k)s, there is no age at which savers must take required minimum distributions.

IRA contributions reached a record high in the first quarter, Fidelity’s analysis found, with Roth IRAs making up 67% of contributions. The number of Roth conversions, meanwhile, jumped 41% year-over-year. Roth conversions are a way to move money from traditional pre-tax retirement funds into after-tax Roth accounts.

Financial planners say a market downdraft such as the one in March creates an ideal opportunity for conversions. That’s because the strategy requires paying income tax on the converted amount in the year of the transaction. If a portfolio’s value is temporarily depressed, converting it to a Roth means that the income tax owed will be less — and if the portfolio value bounces back, it does so in the Roth, where the appreciation won’t be taxed.

Roths are popular with Gen Xers and baby boomers, savers born between 1946 and 1980 who are waking up to the advantages of diversifying beyond taxable and pre-tax accounts. But Fidelity’s analysis also found that more than one in five Gen Z plan participants (those born between 1997 and 2012) contributed to a Roth 401(k) in the first quarter. Younger savers in low tax brackets stand to benefit from decades of tax-free appreciation in Roth accounts, which also can act as a hedge against possible future income-tax hikes.

Fidelity’s retirement account analysis was based on 24.8 million participants in 401(k)s and 18.9 million IRA accounts.