The Roth IRA has been popular for more than a decade, but its workplace counterpart—the Roth(k)—has been slower to take off. Many employers held back until Congress clarified their future with the Pension Protection Act of 2006 (PPA) by removing a sunset provision on workplace Roths.

But Dan Roe's wealth management firm didn't hesitate: It established a Roth(k) several months before the PPA was signed into law.

“We were quick to jump on it when it became available,” says Roe, chief investment officer for Budros, Ruhlin & Roe, a fee-only advisory firm based in Columbus, Ohio, serving high-net-worth families and small institutions. Although Roths aren't right for everyone, Roe, 45, splits his own retirement contributions 50-50 between the firm's Roth(k) and traditional tax-sheltered plan.

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“You can only guess where tax rates will go in the future, but we like to see a mix of investments in tax deferred, after-tax personal saving and a Roth,” he says.

Workplace Roths are gaining speed. 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. Fidelity Investments says half of the large workplace plans it serves now offer a Roth(k) option.

The workplace Roth market received a big boost with passage last fall of the Small Business Jobs Act, which removed restrictions on converting 401(k) savings to Roth(k) accounts. Previously, rollovers were limited to Roth IRAs, and people younger than age 59½ generally could do it only when leaving a job. All limits on income for Roth conversions were removed this year under separate legislation.

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The proliferation of Roth(k)s means it's worthwhile to investigate whether it's worth adding to client portfolios. Depending on the tax rate you anticipate for a client in retirement, a Roth(k) or Roth IRA could make sense. Here's a rundown of the pros and cons of a workplace Roth.

Advantages

Higher contribution limits. Like a 401(k), workplace retirement savers can contribute up to $16,500 to a Roth(k)—much higher than the annual combined contribution limit on a Roth and/or traditional IRA. For those accounts, contributions are limited to the lesser of $5,000 or the amount of taxable compensation (or $6,000 for clients over age 50).

No income limit: Roth IRAs can be used only by investors with modified adjusted gross income (AGI) below $177,000 for a joint return, or $120,000 for a single filer. But there's no income eligibility rule for Roth(k) contributions.

Power saving. Roth(k)s offer an especially attractive option to power savers in high tax brackets. Unlike a tax-deferred account, a Roth 401(k) allows you to max out your contribution and pay taxes with additional dollars. “Very high income individuals can max out their accounts because Roth contributions are effectively larger,” says Kaye Thomas, a tax attorney and author of several books on taxes and investing. “For someone in a 35 percent tax bracket, putting $16,000 into a Roth is like putting a much larger figure into a traditional tax-sheltered account.”

Matching contributions. The workplace Roth can be used to generate any matching contribution that might be available from employer — although any matching contributions must go into a tax-deferred account.

Good for younger workers. Roth(k)s and Roth IRAs are favorable for young workers with lower incomes and tax brackets, since taxes are paid upfront. A Hewitt survey found the highest rate of workplace Roth adoption (16.6 percent) among workers age 20-29.

Disadvantages

RMDs. One of the Roth IRA's most important benefits is that no required minimum distributions (RMD) need be taken after age 70½. Roth(k)s are burdened with the same RMD rules that govern 401(k) accounts–although your clients can avoid the Roth(k) RMD by converting Roth(k) assets to a Roth IRA before age 70½.

Investment choices and cost. Mutual fund choices may be better in a Roth IRA than for a Roth(k), although the IRA's costs might be higher. This will depend largely on the size of your client's employer; workplace plans at large companies usually feature lower costs and better investment choices; average 401(k) total plan costs can range as low as 0.20 percent of assets for the largest plans and as high as 5 percent for small employer plans, according to Brightscope.com.

Less flexible withdrawals. In hard economic times, your clients need to maintain a nest egg that can be tapped in an emergency. Roth IRAs can fill that bill, since contributions can be withdrawn tax free by savers over age 59½, so long as the funds have been in the account for five years. But a Roth(k) is subject to the less flexible workplace plan rules – a 10 percent penalty is levied on withdrawals made before age 59½, along with income tax liability.

Taxes in retirement

The toughest question to answer – and the most important – is what the future tax landscape will be years from now. And it's important to separate your expectations about the country's tax situation from your client's.

“We have a huge federal deficit and we'll have to deal with it at some point one way or other,” says Kaye Thomas, a tax attorney and author of several books on taxes and investing. “But people tend to weight their predictions about this in favor of their own political beliefs. Conservatives tend to think rates will stay low and get lower; liberals tend to think the opposite. A financial advisor owes to his client to be objective and not color advice with politics.”

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And even if Congress does boost rates down the road, that doesn't mean your client's personal rate necessarily will be higher in retirement than it is today.

“Lots of pessimists argue that taxes will have to go up dramatically to deal with the federal deficit, so it's better to pay the tax bill now,” says Steve Vernon, a prominent retirement educator and actuary. “That may be true, but your personal rate could still go down dramatically in retirement.

“You need to look at the tax brackets—a middle class person might be in a 25 percent bracket and then slip down to 15 percent in retirement. Let's say that lower bracket rises to 18 percent or 20 percent down the road – it's still lower than where you are today.”

Much depends on anticipating retirement income, and that includes a variety of factors that many of us overlook. “It's highly individual,” says Thomas. “Some people will have built up a lot of pre-tax pension income or tax-sheltered 401k assets that will come out in retirement. Social Security can play a role, and then there people who continue to work.”

Mark Miller is a journalist and author who writes about trends in retirement and aging. He has a special focus on how the baby boomer generation is revising its approach to money, careers and lifestyle after age 50.

Mark edits and publishes RetirementRevised.com, featured as one of the best retirement planning sites on the web in the May 2010 issue of Money Magazine. He writes Retire Smart, a syndicated weekly newspaper column and also contributes weekly to Reuters.com. He is the author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living (John Wiley & Sons, 2010).

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