Many U.S. employers are missing out on an opportunity to help employees with their financial well-being by not offering or fully explaining and promoting the benefits and value of Roth 401(k) contributions, according to retirement experts at Willis Towers Watson. Retirement plan advisers can help them.
According to a Willis Towers Watson survey, the percentage of plan sponsors offering a Roth option has increased from 46% in 2012 to 54% in 2014. However, less than 10% of plan participants that have the option currently make Roth 401(k) contributions.
A report from Willis Towers Watson notes Roth 401(k) contributions can be one of the most tax-effective ways for employees to save for retirement. With Roth 401(k) contributions, workers make contributions using after-tax dollars and are able to take tax-free withdrawals at retirement. More importantly, Roth contributions can offer tax diversification for many retirees as they begin to take pensions, employer-match contributions from regular 401(k) plans and other taxable income. And unlike with regular 401(k)s and Social Security, Roth 401(k) contributions are not subject to minimum distribution requirements after age 70 ½ if they are rolled over to a Roth IRA.
“When employees bypass Roth 401(k) contributions, they unnecessarily narrow their tools for tax-effective retirement savings. For some, using distributions before age 65 may enable qualification for health care subsidies under the Affordable Care Act. Roth contributions can also help some retirees avoid the tax torpedo, which can increase a retiree’s marginal tax rate based on the tax phase-in on certain Social Security benefits,” says Kevin Wagner, a senior retirement consultant at Willis Towers Watson in Southfield, Michigan.
“One other real important point,” Wagner tells PLANADVISER, “is tax diversification is helpful since participants don’t know what the tax rules will be in the future. Having savings in different categories can address changes in tax laws.”NEXT: Steps to promote Roth savings accounts to plan participants
To help boost employees’ understanding of the savings opportunity the Roth option offers, Willis Towers Watson suggests advisers and/or plan sponsors:
Communicate program features and benefits clearly and regularly. Because one size does not fit all and the value of Roth contributions may change over time even for the same employee, employees should be segmented to identify their needs based on life stages, life events and other characteristics. Communications should be tailored to these segments, and messages should be short and action-oriented.
Wagner offers this example: “If a plan participant is now in the 25% tax bracket, and he puts money in a Roth account, that money will be taxed at 25%. However, if in retirement, he is in the 0% tax bracket, he’s made a mistake by contributing to a Roth because even pre-tax savings would be taxed at 0%.”
Provide effective retirement planning modelers. Modeling tools can be effective at helping employees better understand their retirement plan options. When evaluating retirement planning modelers, Willis Towers Watson suggests making sure that the modeler selected includes total estimated retirement income, pay growth, inflation, tax effects and health care costs.
Implement a process to monitor employee financial well-being on an ongoing basis through plan-level analysis focused on when employees will be financially ready to retire.
If it is known what decisions participants are making with their money, plan advisers and sponsors can see if participants are making the right decisions, and reach out with prompts, Wagner explains. For example, he says, if participants are not putting anywhere near enough money in to afford retirement, they should receive communication that they are not saving enough. Also, if a Roth option is available in the plan and no one younger than 35 is using it, advisers or sponsors can reach out to make participants understand that with growing careers and salaries, their savings may put them in a higher tax bracket in retirement, and using the Roth option would be a good idea.
“The basic concept here is trying to optimize the plan, and one of the easiest ways to create value without spending dollars is helping employees make good decisions,” Wagner says.The Willis Towers Watson report can be downloaded from here.