Employees at Associated Agencies, an insurance company in Rolling Hills, Ill., have joined the small, but growing, number of workers with a new option for retirement savings: the Roth 401(k).
First approved by Congress in 2001, but only available as of Jan. 1, 2006, the Roth 401(k), like its traditional defined contribution counterparts, allows employees to save for retirement as they work.
Unlike typical 401(k) plans, through which employees contribute savings on a pre-tax basis, deferring tribute to Uncle Sam usually until after retirement, workers enrolled in a Roth 401(k) plan stow away post-tax earnings now, but pay no taxes when they take distributions later.
"We looked at this, and we saw no reason why we shouldn't offer it," said Robert Schrayer, the president of Associated Agencies, which employs 120 people. The company's existing plan already had a remarkably high participation rate of 92%, he said. "For some, this is a better time for them to pay taxes than it will be when they take the money out," he said. "People were very interested."
But Schrayer is among a minority of plan sponsors to add the new 401(k) option. In fact, although employees whose companies offer the new Roth 401(k) have readily selected it, employers have been slower to catch on, according to a recent study by Hewitt Associates, a human resources consulting firm based in Lincolnshire, Ill.
"A lot of business owners will take the position, If it's not broken, why fix it?'" said Jim Huller, president of Maximum Wealth Advisors in Roanoke, Ind.
Huller began promoting the plans before they kicked in on Jan. 1 but said he only got a lukewarm reception from would-be sponsors. Those that already had plans saw no reason to add another. Others that had plans in the past, but failed to generate enough interest among employees to clear discrimination tests, had already given up on the idea of going to the trouble of qualifying yet again.
Then came tax time. "Around April 15, it sunk in," he said. Since then, Huller has begun developing Roth 401(k) programs for three companies, including a medical office and a construction company.
The Hartford Financial Services Retirement Plan Group of Simsbury, Conn., sees financial advisers like Huller as its front-line offense in the continued promotion and popularity of Roth 401(k)s.
Not only can advisers, equipped with information and research about the benefits of these programs, help increase participation for plan providers, but they can garner business for themselves, said Tom Foster national spokesman for The Hartford.
"We'll educate them in the technical aspects and how to turn those technical aspects into selling opportunities," Foster said. After all, when people retire or leave a company, the person they are most likely to turn to for help will be the adviser who first introduced them to the program, he said.
The second-line offense consists of employers, or plan sponsors themselves, Foster said. Plan providers must assure sponsors that the added program will not bring with it burdensome paperwork or extra expenses.
"The main choice an employer has to make is whether the Roth 401(k) is an option they should be offering," Foster said. The Hartford ensures employers incur no added costs and offers the same products to employees in both plans. Employees can choose a Roth 401(k), a traditional 401(k) or both.
In the case of Associated Agencies, which uses Transamerica Retirement Services of Los Angeles for both its traditional and Roth 401(k) plans, Schrayer described the added costs for the sponsor-mainly separate payroll and benefits accounting-as "very, very, minor." Transamerica handles the time-consuming year-end paperwork and employee statements, Schrayer said.
"Once they understand it really isn't that big a deal, you're going to see more and more employers jumping on this," said Foster. The Hartford has signed on 1,000 plan sponsors in the seven months since the law took effect.
As for the employees who opt for a Roth 401(k), Hewitt found the plans most popular among younger, lower-wage earners, who hope to see their compensation-and their tax brackets-rise as they approach retirement, but are not as concerned about reducing their tax liabilities just yet.
In fact, in its survey of 60,000 employees across three large companies that offer Roth 401(k)s, Hewitt found that 90 days after the Roth 401(k) was introduced, about 8% of employees had chosen to enroll. Of those who opted for the Roth, 14% were in their 20s, compared to 4% in their 50s. Nearly 25% were first-time participants, or those who had not already enrolled in the company's existing, traditional 401(k).
Skeptics of the new plans have suggested that because employees pay after-tax money, they may be inclined to contribute less, but the Hewitt study found that the contribution rate among new participants was virtually unchanged. "This is good news for companies that are considering adding the Roth 401(k) option," said Lori Lucas, director of retirement research at Hewitt.
About 7% of the workers in Hewitt's survey sample who were already enrolled in their company's existing 401(k) plans, took advantage of the new Roth option. Those who changed their election-either completely or in part-from a traditional 401(k) to the new Roth option, socked away 3% more, or an average of 11.6% of their salaries, than employees who stayed in the existing plan, who, on average, saved 8.8% of their wages.
The increased levels do not show, necessarily, that employees who invest in Roth 401(k)s save more, Lucas warned. After all, employee inertia has always been among the biggest bugaboos of the 401(k) industry. It does, however, prove that they don't contribute less, a result many detractors of the legislation first predicted.
The Roth 401(k) is not only suited for the lower-income, lower-tax bracket individuals. It can also complement the retirement strategies of high-net-worth investors, Huller noted. For example, the Internal Revenue Service prohibits individuals earning more than $95,000 or couples who file jointly and earn $150,000 or more to contribute to Roth IRAs. Those who are eligible to participate can contribute no more than $4,000 per year.
But the contribution cap for a Roth 401(k), like a traditional plan, is $15,000, and there are no income limits. While the traditional 401(k) makes sense for those who want to lower their tax bracket now, having some already-taxed money for retirement helps hedge against potential rate hikes later.
"It's a great deal," said Huller of
the Roth 401(k). "The big problem is education."
Foster agrees, and believes with time, interest in Roth 401(k)s among high-net-worth individuals will increase. Eventually that demographic may dominate the Roth 401(k) market share.
He described a group of physicians who have roughly $2 million each saved in 401(k) plans. Right now, that money will be taxed upon distribution, but had these doctors used Roth 401(k) plans, they would be looking at tax-free payouts. "It's a great opportunity not only for themselves, but for their beneficiaries," he said.
With time, Foster also foresees new products, such as Roth 401(k)s that offer more aggressive investment options, so that savvy investors might use the post-tax accounts for portfolio growth, while reserving traditional 401(k)s for more conservative savings.
"From an adviser standpoint, I see this as a great opportunity, trying to make them understand what the variables are," Foster said.
Huller believes that with the twilight of defined benefit plans on the horizon, greater acceptance of both traditional and Roth 401(k) plans is imminent. "If you take the chance to sit down and really explain it to people, they're always happier," he said.
The legislation that created the Roth 401(k), like other provisions of the Economic Growth and Tax Relief Reconciliation Act, calls for the Roth 401(k) to expire in 2010, unless it is extended by Congress. However, many are optimistic that the provisions, along with others included in the act, such as IRA contribution limit increases and 529 plans, will be extended.
"There is a lot of push," Foster said.
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