Plan sponsor adoption of 401(k) Roth provisions has jumped in recent years, thanks in part to IRS rules that took effect last year. Those make it possible for retirement plan participants to convert existing 401(k) plan balances to Roth 401(k) plan balances, whether or not the participant was eligible for a distribution.
According to the Plan Sponsor Council of Americas annual surveys of 401(k) and profit sharing plans, nearly 54% of all plans 401(k) and profit sharing plans offered Roth 401(k) deferrals in 2012, up from 49% in 2011.
Because Roth 401(k) deferrals are taxable in the year they are earned rather than the year they are distributed out of the plan, the feature is a good tax planning tool for all employees in general, and executives in particular, says Robert Lawton, president of Lawton Retirement Plan Consultants, LLC and a regular blogger for EBN.
Especially with the executives who might be playing with tax losses or huge gains every year, he says. They can go to their accountant and say, Hey, look, I've got this new feature in my retirement plan that can allow me to generate a bunch of taxable income in any particular year where I might be realizing a bunch of losses or I have to take a loss on a transaction or something.
In addition, the Roth 401(k) concept is appealing if youre a believer that, right now, tax rates are at historic lows at the state and federal level in the U.S. says Lawton. Im one of those people who believes that to be true. I think tax rates at the state and federal level are only going to go up.
From a compliance and regulatory perspective, I dont see any reason why a plan sponsor would not want a Roth provision, says Anton Bayer, CEO, Up Capital Management, a money management firm in Sacramento, Calif. We dont deter clients from adding a Roth provision.
However, he does caution plan participants to tread carefully with Roth 401(k)s, mainly because youre making a deal with a partner that has a very poor track record of keeping its promises. 10, 15 years from now, you dont know whos going to be in Congress, whos going to be the President and what the tax law will be.
So while he sees no issues with plan sponsors amending their 401(k) plans to offer a Roth provision, he would not counsel plan participants necessarily take advantage of it.
Were not a very strong proponent of betting that the government five, 10, 15 or 20 years from now is going to honor its commitment that youll be able to get your money back, says Bayer.
Added flexibility
There are recordkeeping costs associated with adding a Roth 401(k) provision, in addition to whatever costs are associated with amending the plan to allow for the provision, but Lawton believes the costs are minimal given the added flexibility the Roth 401(k) offers plan participants.
Up until recently, most recordkeepers werent charging anything additional to recordkeep a Roth 401(k) account. [now], if it does, Ive seen typical charges along the order of a thousand dollars a year, he says. Depending on plan size, the cost of making this change for a plan sponsor could be really small. If youre giving your executive group or your participants in general a great deal of flexibility at very little or no cost, how can it not be a winner?
And while the number of plan sponsors offering Roth 401(k)s has increased, employee take-up of the feature is less clear.
I would say the majority probably at least 75% of our plans do have a Roth provision in them, says Karen Roberts, vice president, plan operations and compliance with CBIZ Retirement Plan Services. Are they being used? The usage is much lower, actually, than the number of plans that have it.
Still, according to a Wells Fargo survey looking at the first quarter of 2013, 10% of participants in the defined contribution plans it administered chose to contribute to a Roth 401(k) when it was available, up from 8.9% reported in the first quarter of 2012. Notably, 16.9% of participants under the age of 30 contributed to a Roth 401(k), up from 15.2%.
A 2013 study from the National Bureau of Economic Research, meanwhile, that looked at administrative data from 12 companies that added Roth 401(k) option between 2006 and 2010, found that approximately one year after the Roth feature is introduced, 9% of 401(k) participants have positive Roth balances. On average, Roth balances made up only 1.8% of total 401(k) balances at the companies studied.
Roberts notes employers shouldnt underestimate the value of adding flexibility to their 401(k) plans, particularly if the price is minimal and it can generate favor among employees. When I consult with a client that doesnt have [Roth 401(k)], the way I look at it for them is, its really a win-win situation, she says. Youre providing flexibility which, in turn, to some degree, gives the employer some goodwill and it really doesnt cost the plan sponsor anything extra, other than potentially the cost of a plan amendment.
