I have been surprised by the lack of uptake on Roth 401(k) accounts.
As background, a Roth 401(k) account is one in which deferrals are made on an after-tax basis, rather than before tax. Under Roth, if you pay taxes on your deferrals, all of the benefits, both principal and income, come out tax free.
Based on the analysis I have seen, Roth 401(k) accounts will likely be “winners” for anyone who can afford to make the full 401(k) deferral ($15,500 if you are under 50, and $20,500 if you are 50 or older), and pay the taxes on top of that. And that analysis applies even if tax rates don’t go up; however, if they do, the advantage is even greater. Who are those people? Obvious candidates are doctors, lawyers, and other professionals.
In fact, our law firm adopted a Roth feature at the earliest possible date, January 1, 2006. As a result, the participants who are making Roth deferrals now have almost two years of contributions, plus earnings, that will come out tax free at retirement.
I can understand why companies with hundreds or thousands of low- and moderate-paid employees may be reluctant to add the feature. HR and benefits people tell me that they are having a difficult time getting those employees to participate without adding another complex issue to the equation.
But, organizations with large numbers of high-paid employees should seriously consider adding a Roth feature to their 401(k) plans. This is the right time to do the analysis, since January 1 is a logical starting date for these deferrals.
As a word of caution, this article discusses only some of the issues for Roth. No one should make a decision on the limited information in this article. Instead, you should consult with a knowledgeable attorney or adviser to fully discuss and understand the pros and cons.
Also, I don’t mean to imply that only a few adventurous firms have added Roth to their plans. Vanguard recently reported that, by the end of 2006, 14% of the 401(k) plans that it studied had a Roth feature. Vanguard also reported that only 5% of the participants in those plans had elected to use the feature. That is not particularly surprising since the advantages are the clearest for the highest paid employees.
Disclaimer Required by IRS Rules of Practice:
Any discussion of tax matters contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding any penalties that may be imposed under Federal tax laws.