Roth Will Be 21 Years Old Next Year

What Should A Plan Sponsor Do Now That Roth Provisions Are Likely Here To Stay?!  

Baby, look at you now!  Next year, Roth will be 21 years old (See blog Roth Celebrates its 20th Anniversary!)

Last year, as part of the Tax Cuts & Jobs Act of 2017 legislative process, the Plan Sponsor Council of America (PSCA) became a founding member of the Save Our Savings Coalition (SOS). SOS was organized to resist proposals that would have eliminated pre-tax contributions to 401(k), 403(b) or 457(b) plans – only allowing Roth after-tax contribution.

PSCA and SOS succeeded. As a plan sponsor, you can still choose between a pre-tax only plan or a plan that offers a choice of pre-tax and Roth.  But, did you keep the Roth choice to yourself?  If so, you may want to give Roth a second look when you are making plans for 2019 - now that it is “all grown up.”

Some believe Roth is better - and, for some workers, Roth IS better!  

Last year, those who wanted to eliminate or curtail pre-tax contributions (Rothification) cited a specific study,  and argued that Roth is better because:  

• People who choose Roth often save the same percentage of pay, and   
• Retirement preparation is improved. But, there are too many variables to assert Roth is always better. 

Some items to consider include:

• A worker is not likely to experience the same income tax rates throughout his or her period of employment and retirement, 
• Pre-tax savings avoid taxes at the top marginal rate; but retirement payouts are often taxed at effective (average) rates, 
• State income tax rates may vary – when comparing state income taxes while employed and in retirement, or where the state of residence while employed differs from the state a worker chooses in retirement,   
• While the cited study showed workers who choose Roth over pre-tax do not reduce their overall savings rate, the average Roth contribution was a range of only .11% to 1.12% of pay, and there was little difference in total contributions between the control group (4.53% of pay) and the experiment group (4.67% of pay), and 
• The cited study used a survey to try to reveal workers’ intuition about optimal choices. But the study itself confirms that “individuals, on average, do not respond rationally to the relative economic incentives.”  That’s no surprise to plan sponsors who increasingly deploy automatic enrollment, automatic escalation and other choice architecture features such as Qualified Default Investment Alternatives, etc. 

PSCA’s 60th annual survey shows 63% of plans offer Roth. That same survey shows that only 18.1% of participants contributed on a Roth basis. These survey data are not significantly different compared to other surveys.  If you don’t offer Roth, perhaps it is time to reconsider. Roth isn’t for everyone. But, in the 12 years since Roth became available as an option where you already offer a 401(k) or 403(b) with pre-tax contributions, Roth features have demonstrated their value.  

Here are a few examples why Roth 401(k), 403(b) or 457(b) deferrals might be preferable. Some workers:

• are just starting their careers and may currently be subject to a lower marginal income tax rate,
• seek tax diversification as a hedge against potentially higher future income tax rates in years to come, 
• are employed in a state that doesn’t currently have an income tax, 
• want to build a legacy accumulation of assets that will not be subject to minimum required distributions,    
• are limited by the 2018 Internal Revenue Code Section 402(g) contribution maximum of $18,500 and/or the 2018  414(v) catch-up contribution maximum of $6,000, and they know that an equal amount of contributions on a Roth basis represents a significantly greater savings rate,   
• want to manage their taxable payouts in retirement with an eye on avoiding Medicare Part B and Part D income surcharges, 
• are highly paid and are not eligible to contribute to an IRA on a Roth basis, and/or 
• want to convert taxable monies to a Roth basis today, but they are not currently eligible for a distribution that can be rolled over and converted into a Roth IRA where plans with Roth features can permit in-plan conversions at any time.      

When it comes to a comparison of pre-tax and Roth contributions, choice offers significant value depending on the personal circumstance of each saver.  And, circumstances change, so, a worker who perhaps preferred Roth at an earlier age will change to a pre-tax basis later in his or her working career (or vice versa).  Since Roth IRAs have been available for over 20 years and since Roth 401(k), 403(b) and 457(b) have been available for over 12 years, Roth is no longer a new fad, nor is it an unknown quantity.  

Finally, perhaps someday legislators will again suggest pre-tax contributions be curtailed or eliminated. Only if all plans offer Roth features will PSCA and other members of the SOS Coalition have the data we need to confirm workers’ savings preferences.  If everyone offers a Roth alternative, we’ll know who has rejected Roth. We’ll know who has rejected pre-tax. We’ll know who has selected both. And, we’ll know the relative contribution rates and how workers responded to having this choice. Most importantly, we will be able to confirm to legislators that the only workers who will be affected by the curtailment or elimination of pre-tax contributions will be those workers who preferred pre-tax!