Finding Its Place

If Roth 401(k) were a human being, he would be going through an existential crisis.
Reported by
Michael Wandelmaier

Employer adoption of the Roth feature to their 401(k) plans has been significant—37.4% of overall plans now have a Roth 401(k) feature, according to the 2011 PLANSPONSOR DC Survey. However, even as that number grows—and faster than the adoption of target-date funds—plan participants are not taking advantage of it. In fact, only 9% of employees who have a Roth 401(k) option have chosen it as a retirement savings vehicle, according to research from Vanguard.  

It seems that, for many in the retirement plan industry, that mismatch isn’t cause for concern; making the unpopular Roth 401(k) more popular with participants is far from top of mind. The biggest problem, say advisers, is getting Americans to increase their savings to get them closer to a secure retirement. Anything else is secondary, and if it’s something that might distract the industry or the participants from solving the primary problem, such as education about the Roth savings options, then it should be placed on a back burner.  

Is there merit in this argument? Americans are not saving enough; a recent survey from Allianz Life Insurance Company found that 30% of non-retirees either have decreased the amount they’ve been saving for retirement or have stopped saving all together since the recession began in 2008, and more than one-quarter (28%) have not started saving for retirement at all. Furthermore, data from Financial Finesse show that 14% of employees report they are on track to replace 80% of their income (or reach their specific goal) in retirement to achieve a comfortable standard of living. More than three-quarters (78%) of those that are not prepared have not run a retirement projection in order to determine how much they should save and how they should invest their savings.  

Today’s mantras to participants from advisers, vendors, and sponsors, are to increase deferral rates; to analyze gap ratios; and to have a properly diversified portfolio to protect against market volatility (something that surely will catch a participant’s ear in today’s environment).  

So, then, why does the Roth 401(k) exist? Is it worth it for plan sponsors to include in their plans if participants aren’t being educated about it? Why are advisers hesitant to broach the subject with participants?  

The “Non-Problem” Problem 

“[The] lack of savings by our population is going to be one of the biggest crises our country will face,” says Mark Ratay, financial adviser with The Ratay Group and Corporate Retirement Director of Morgan Stanley Smith Barney in Lisle, Illinois. “But when you go out there and start talking to the masses, all but the most sophisticated investors don’t get it. They’re already confused about saving in a 401(k). So, when you get into the Roth topic, you’re throwing one more thing up in the air to confuse them,” he says.  

“Of all the issues that are out there, I’m not sure I would have this at the top of my list, since there are so many variables with Roth. We all know that [participants] are not saving enough, and the issue of lifetime income from a 401(k) account is taking up a good amount of education time,” says Sean Deviney, Financial Planner, Provenance Wealth Advisors in Fort Lauderdale, Florida, agreeing with Ratay’s sentiment.  

“I do think the Roth is a great option, but it isn’t a ‘problem’; it just hasn’t been adopted as quickly as the industry thought it would be,” he says, adding that the Roth 401(k) option is more of a tax planning tool, not necessarily a better alternative than the traditional 401(k).  

At the very least, advisers say, plan sponsors should have the Roth option in their 401(k)s.  

“Plans should offer as many features as possible, including the Roth” says John Prichard, Senior Vice President, Heffernan Financial Services in San Francisco. “Participants who understand it, take it but it is not the most important thing by a long shot. Our whole tax structure right now is in flux; everything’s staying the same and everything’s changing. It’s a nice element, but it’s not the most important.”  

Prichard says his firm does a “soft sell” of the Roth option. They advise sponsors to have it in the plan for those participants who want it, they inform participants that the option is there, but they do not spend time educating about it. “We don’t want to focus on it. What we’re seeing is, the participants who know about it, gravitate to it, and the vast majority doesn’t pay any attention to it. It’s a very small percentage using it and they tend to be the highly comped people. When we do employee education meetings, we include it in a slide, but we don’t make a big deal about it; that’s been our tactic.”  

Other Approaches 

Simply put, the Roth versus pre-tax decision can be thought of as the second step in a retirement planning discussion, says Maria Bruno, a Roth expert at Vanguard. “It’s part of the implementation—the where and how,” she says. The first step employees must take is deciding whether to participate in their work-sponsored plan. Once that decision is made, the next logical step is to decide whether they want a Roth or traditional plan. “It’s right up there with which investments to select,” she says.  

Ratay’s colleague, Dan Peluse, Corporate Retirement Director at Morgan Stanley Smith Barney, contends that more participants would benefit from it if they understood it. “That’s where we’re missing the boat,” he says. 

E. Thomas Foster, The Hartford’s national spokesperson for qualified retirement plans, agrees that education is key—and it’s not just important for participants.  

“Advisers need to get the basic components across to participants. It’s their job and, if they don’t feel comfortable [with the task], they have experts to help them,” says Foster. “Don’t hold back on delivering a message just because you don’t feel comfortable with it. There are a lot of complex moving parts, but just focus on the basics.” 

He added that many advisers don’t typically like to venture outside of their comfort zones and prefer to discuss matters they feel completely knowledgeable about, which might not include Roth plan features or benefits. “You need to understand where your resources are. If there’s something that might help a client, we should be using all tools available to us.”  

If the nuts and bolts of a Roth 401(k) plan are described, and a participant is still confused, Foster suggests using tools. “There are several online tools that participants can use in order to see their options; advisers should have these tools with them when going into educational meetings.” Minds have a hard time grasping the mathematics, he says, but online calculator tools can be a big help.  

“We don’t want to get involved in ‘paralysis by analysis,’ but at least give them the option. If you don’t educate them on the Roth option, you’ve taken away a choice that everyone in a 401(k) should have. It might be another level in need of explanation, but that’s our role,” says Foster.  

Automatic Roth? 

Maybe there is another way to look at the Roth option. Right now, it seems that the general consensus is to have it in the plan for those participants who already know about it and want it, and let everyone else stick with the status quo 401(k). 

Ratay would remind advisers in this camp that there are people who would benefit from the Roth option, because if there weren’t any possible beneficiaries, it wouldn’t exist and no one would be using it. He believes that the problem is nailing down exactly who it is that can benefit the most from investing in a Roth 401(k) and building up from there.  

 “If there is a group that has easily recognizable benefits from a Roth, maybe we can auto-enroll them into it rather than the traditional?” Ratay asks. He says that, if a conclusive study were done that proved people younger than 30, for instance, are nearly guaranteed to benefit from a Roth, the industry would then boost its pitch of the Roth 401(k). As far as he knows, such a study has not been done, however.  

 “If you make it optional, you won’t get the people who would benefit. The best trends that have come out of the PPA of 2006 are automatic features. You don’t like forcing anyone into anything, but that’s the only way to drive results in participant-directed plans,” Peluse adds.  

Whatever the approach, Foster believes that it will still take a while for the Roth option to gain popularity but, he says, as the tax debate in the U.S. continues to get more attention, more participants will start to see the possible implications of higher taxes in the future. —Nicole Bliman