Whether you sponsor a large or small 401(k) plan, the addition of a Roth in-plan conversion feature may be viewed by your executives as an important tax planning tool. A major benefit of Roth accounts is that vested balances residing in the accounts for five or more years may be withdrawn tax free (contributions and earnings) when a distributable event occurs.
Roth in-plan conversions are a unique tax planning tool since they are the only investments I can think of where the investor has control over when an investment is taxed, without actually having to liquidate the investment. Normally, tax on an investment is triggered when it is sold, not re-characterized into a different account or form. Consider these other reasons to offer a Roth in-plan conversion feature in your 401(k) plan:
- Political. Like it or not, the benefits and compensation packages of your executives are solidly in the cross-hairs of our nation's legislators. Whether it is from an income equality perspective or a matter of the conventional wisdom of the moment, its likely that executive comp and benefits will remain under attack. Any enhancement you can provide this group would seem to be welcome.
- Political trend. It is pretty clear that the Obama administration feels that retirement benefits should have their limits. How might future administrations view the issue? Many experts believe that a Hillary Clinton presidency is inevitable. That could leave benefits and compensation policy in the hands of Democratic policymakers for the next 10 years. If that happens, do you think tax rates will be higher in the future? Executives might feel that it makes sense to tax some of their retirement plan benefits now at what might be historically low tax rates.
- Low cost. With such a powerful tool available (where else can you choose when to have an investment taxed without having to sell it?) the cost to implement this plan change must be enormous, right? Not so. You will need to amend your 401(k) plan to add the feature and then communicate the change to participants. Depending upon the size of the plan, the total cost of a plan amendment and communication materials falls somewhere between $2,500 and $5,000.
- Strategic. I believe that every 401(k) plan participant should establish a Roth 401(k) account. Why? If for no other reason than to get the five-year clock started. Remember, a Roth account has to be in existence for five years before amounts may with withdrawn tax-free. However, every dollar doesnt need to be in an account for exactly five years. Don't believe that tax rates will be higher in the future? Why not start the Roth five-year clock ticking anyway? It costs nothing (put $10 in it!) and you have nothing to lose.
- Huge benefit to young workers. Besides executives, it would seem that those employees just starting their careers might benefit greatly from using Roth 401(k) plan accounts as well. Since these workers have 30 or 40 years to work, just think of the tax-free balances they could accumulate over their careers. Even if you are cynical and believe the government will change its mind and begin taxing these balances if they get too large, why not start to fill up a Roth bucket now anyway?
There appears to be no downside associated with adding a Roth in-plan conversion feature. It will not cost anything additional to administer each year and is a nice option to offer employees.
Robert C. Lawton, AIF, CRPS is president of Lawton Retirement Plan Consultants, LLC, an RIA firm helping retirement plan sponsors with their investment, fiduciary, employee education and compliance responsibilities. He may be contacted at firstname.lastname@example.org or 414.828.4015.
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