CHICAGO | Tue., May 8, 2012 7:10pm EDT (Reuters) — Roth workplace accounts, which have grown more popular in recent years, are about to get a shot in the arm from Uncle Sam. This week the federal government started rolling out a Roth option to 3.3 million employees who participate in its main retirement program.

Unlike tax-deferred retirement accounts, Roth contributions are made with after-tax dollars. Contributions and investment returns can be withdrawn tax-free as long as the account holder is over age 59-1/2 and the account has been established for at least five years.

High-earning workers in top marginal brackets who anticipate lower income-tax rates in retirement are better off in tax-qualified accounts like traditional 401(k)s. However, a Roth is a good fit for younger workers — especially if they expect their incomes to rise — who want to protect themselves against possible future higher marginal tax rates.

In the private sector, 39% of retirement plans offer a Roth savings option, with 29% more likely to add it this year, according to a survey of more than 500 employers by consulting firm Aon Hewitt. But the sign-up rate at companies that offer the option has been slow. About 6% of eligible workers use Roths, according to Alison Borland, Aon Hewitt's vice president of retirement product strategy.

Borland faults the added decision-making burden associated with a Roth. "Using a Roth requires employees to analyze and make decisions about where their future tax rates will be, along with all the other decisions about how much to contribute and how to invest."

A recent survey by T. Rowe Price shows that many investors don't fully understand the differences between Roths and tax-deferred investing. About one-fifth of investors age 21 to 50 surveyed mistakenly thought traditional IRAs let investors withdraw contributions and earnings tax-free — which is actually a key feature of the Roth, not the traditional IRA.

Borland says Uncle Sam's adoption of Roths could accelerate the trend in the private sector. "If it raises awareness in the general population, that could translate into more workers using it at work."

The sign-up rate for workplace Roth accounts in the federal government's huge Thrift Savings Plan could be higher than in the private sector because of a twist on the Roth benefit that will be available to military personnel stationed in combat zones. Military personnel are granted a "combat zone tax exclusion" for any month served in a combat zone, meaning their pay for that month is excluded from gross income subject to income tax.

Vanderslice says most federal employees she hears from still need to be educated about the Roth option, although the government has sent two brochures to the federal workforce.

The TSP is similar to a private-sector 401(k) plan. Workers receive a matching contribution ranging from 1% to 5%, depending on their contribution level. They can choose among 10 investment options, including target-date plans and an array of equity and bond funds. Assets totaled $308 billion in March, with 4.5 million total account holders (including retirees and separated workers). TSP participants also receive a small defined-benefit pension and contribute to Social Security, for which they qualify to receive full benefits.

Congress approved TSP Roths almost three years ago as part of the Thrift Savings Plan Enhancement Act of 2009, which introduced several other reforms and improvements, all of which were implemented before the Roth. That has frustrated some federal workers, says Vanderslice. "Tax rates have been low that entire time, and the Bush tax cuts are set to expire, so there isn't much time left to contribute to a Roth at the lower rate."

While the TSP is ready to receive Roth contributions as of this week, availability to federal workers depends on rollouts by more than 100 government payroll offices. By far the largest is the Defense Finance and Accounting Service (DFAS), which handles payroll for the military, numerous other departments and the White House. DFAS will begin phasing in the Roth option in June and will finish up in October.

© 2011 Thomson Reuters. Click for Restrictions.

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