Despite a stumbling start, the Roth 401(k) feature appears to be gaining ground in the defined contribution plan space.
Considering that more Americans will see the need to diversify their tax liability on retirement income, leading retirement experts commonly assume most large plan sponsors eventually will have to adopt a Roth 401(k). The growth likely can be attributed to plan sponsors’ diminished concerns over regulatory uncertainty and administrative complications.
When the Roth option was introduced, there was a lot of excitement among service providers and plan sponsors, but also a large amount of confusion. Much of the anxiety stemmed from whether federal regulators would craft guidelines that “would be clear to both employers and service providers in terms of implementing a Roth 401(k) feature.” To complicate matters, regulators took their time in issuing final regulations, which took a lot of the excitement out of the air
The vast majority of Americans still make salary reduction contributions to traditional 401(k)s, mainly due to the fact that participants weren’t allowed to make a Roth contribution into a 401(k) until 2006. More companies now offer Roth 401(k)s, and many firms that don’t yet provide the option are considering adding it in the future.
Some Roth 401(k) basics:
· Contributions are after-tax and do not affect current taxable income reported.
· The maximum employee annual contribution for 2008 is $15,500. For employees aged 50 or older, the law now permits a “catch up” contribution of an additional $5,000 in 2008.
· When employees sign up to make Roth-designated 401(k) contributions (much like a regular 401(k)), their contribution usually is taken out their salary automatically.
· When participants elect to contribute to a Roth 401(k), employer matches will be made into a regular 401(k). Essentially, participants will have both a Roth 401(k) account and a traditional 401(k).
· There are no income restrictions as there are with a Roth IRA. Regardless of how much money participants make, they are entitled to make a maximum annual contribution of $15,500 for 2008.
· Participants can take a loan from a Roth 401(k), in much the same way they can from a regular 401(k).
· If participants don’t roll a Roth 401(k) over into a Roth IRA before they reach age 70.5, generally, they will be required to take a required minimum distribution, similar to RMD rules for a regular IRA or regular 401(k).
· For 403(b) plan participants, all the rules regarding Roth contributions are more or less the same as those for 401(k) plans.
Many employers have been slow to amend existing 401(k) plans to give employees the choice of making a Roth contribution. Many employers don’t want to deal with the extra work and administrative responsibilities that come with making such a change, but that shouldn’t be an inhibitor. Most plan service providers can provide significant assistance to plan sponsors in adopting a Roth 401(k) provision.
Given the uncertainty of future tax laws, I really like the idea of allowing participants the opportunity to diversify their tax situation. Just take a look at the tax rate rollercoaster over the last few decades. I think there is a tendency by most people to make savings decisions based on today’s income, long-term capital gains or dividend rates, but it is much more important to consider the rates at the time money is being distributed out of the retirement plan.
I don’t think of that as a digital decision — offer a regular 401(k) or a Roth 401(k). Both pre- and post-tax salary deferral options can be offered. To understand how participants are reacting to the Roth 401(k), take look at an analysis by the Merrill Lynch Retirement Group on their plan base:
· More than 13,000 participants (6 percent of those eligible in plans offering the option) are contributing to a Roth 401(k) account.
· The number of participants contributing to a Roth 401(k) is up 37 percent in the first quarter of 2008.
· Almost 20 percent of plans with a Roth 401(k) option have participation rates of 10 percent or more; 10 percent of plans have participation rates of 20 percent or more.
· Total assets in Roth 401(k) accounts are $70 million, with $28 million contributed in the first three months of 2008. The average contribution is about $5,400.
For more information on the Roth 401(k), talk to your plan service provide, who can assist you in making an informed decision on whether to adopt a Roth 401(k) and educate your participants on the new feature.
(Source: “Merrill Lynch sees uptick in Roth 401(k)s,” Lydell C. Bridgeford, May 20, http://ebn.benefitnews.com.)
David Sanza is a client relationship manager for EPIC Advisors Inc., a full-service retirement plan service provider with emphasis on 401(k) plans. Offices are located at 150 State St., Suite 200, Rochester, N.Y. 14614; phone (585) 232-9060; www.EPIC1st.com; www.401(k)TALK.com.