Roth 401k Flexible, But Needs Education

Roth 401k

Roth 401k Flexible, But Needs Education

Roth 401k options provide flexibility in approximately 75% of retirement plans, according to T. Rowe Price. Although the Roth 401(k) came into existence in 2006, participant uptake is still quite low — only 7.6% used the Roth 401(k) option in 2018. Does your retirement plan offer a Roth 401(k) option? If not, now may be a good time to consider offering a Roth 401(k) option for your participants.

According to Frank Armstrong III, a Forbes contributor who writes about investments and retirement, adding a Roth 401(k) option can improve a retirement plan. Mr. Armstrong wrote: “From the perspective of the plan sponsor, it’s a no brainer. It should be available on every plan. And you can enhance your plan benefits without one single penny of additional cost to the company.”

The issue, however, is that Roth 401(k) options are not understood very well. They create a lot of confusion for both plan sponsors and participants. Nonetheless, a Roth 401(k) option offers benefits that may be attractive to participants:

  • Whereas 401(k) contributions are made on a pre-tax basis and are taxable upon withdrawal, Roth 401(k) contributions go into the account after-tax. In addition, distributions from a Roth 401(k) option are tax-free after five years and when the participant reaches age 59 1/2.
  • Traditional 401k plans also have required minimum distributions beginning at age 70 1/2. However, Roth 401(k) options allow for a rollover directly into an IRA, avoiding RMD requirements.

Here’s how most experts think about Roth 401(k) options:

  • If a participant expects to be in a lower tax bracket at retirement when they withdraw their savings, then making traditional 401k contributions may be most advantageous.
  • However, if a participant anticipates being in a higher tax bracket at retirement, then a Roth 401k option may be beneficial.

Mr. Armstrong pointed out that a Roth 401k option may be best for participants in their peak earning years. He wrote: “Deduct at high rates and distribute at lower rates. Even if they never made a penny on their contributions, they would come out ahead. Deferring taxes until you are in a lower bracket is always a good strategy.”

Moreover, Mr. Armstrong noted that workers who are just starting their careers in a lower tax bracket should take advantage of the Roth 401k option because they will be able to enjoy receiving tax-free distributions even if they end up a higher tax bracket in retirement. In addition, a Roth 401k option provides an opportunity for participants to hedge their bets against higher taxes later on. It also gives wealthy participants flexibility to do some tax and estate planning now for the future.

However, Mr. Armstrong cautioned that adding a Roth 401k option to your retirement plan requires plan sponsors to provide proper education and awareness to help participants make the most of its benefits. As such, he wrote, “Your investment advisor and/or Third-Party Administrator (TPA) should support your employees with education, guidance, and assistance so they can get the benefit.”

Participants may enjoy the many advantages of a Roth 401k option, provided they are given the opportunity to understand its benefits and put them to good use. If your retirement plan doesn’t currently offer a Roth 401k option, consider initiating a conversation with your plan provider to determine if adding it makes sense for your participants.


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