Don't expect a flood of Roth conversions

Participants consider it a complex decision, industry experts say

020413 newmister
Joshua Newmister thinks there are reasons both younger and older plan participants would want to use a Roth instead of a traditional 401(k).

Although the American Taxpayer Relief Act expands the opportunity for defined contribution plan participants to convert from a traditional pretax contribution option to a Roth after-tax contribution option, some industry professionals doubt there will be a surge of activity.

They say many participants still view a Roth conversion — or even starting a Roth — as a daunting matter requiring them to make complex assumptions about future earnings and taxes. They also point out that Roth options in DC plans have received lukewarm responses from participants even though more plans are offering a Roth opportunity.

“Roth accounts have not been widely accepted by participants,” said David Ray, vice president of national sales for TIAA-CREF in Dallas. The new law could provide “a great opportunity” for some people depending on individual finances, but ”we don't see significant demand unless providers promote this,” he added.

Providers and plan executives aren't sure how much the new law will affect participant interest in choosing a Roth option or converting to one.

Joshua Newmister, global retirement program manager for Symantec Corp., Mountain View, Calif., said he can't predict how the new law would affect participants in his company's $900 million 401(k) plan. Although 12% of participants have chosen a Roth option, no one has converted from a traditional 401(k) to a Roth 401(k).

“Obviously Roth is still new compared to pretax in 401(k) plans, and most automatic-enrollment designs have pretax as the default deferral, hence the relatively lower utilization,” he said. “It will take some time before employers and employees embrace the full benefit of the Roth feature and create comprehensive communication/education of how to utilize both pretax and Roth deferral sources in retirement planning.”

Mr. Newmister said younger employees “could likely benefit from Roth contributions early in their career where they could likely be earning less than they will be later in their careers.” Other employees, with higher incomes, “may desire to pay the tax now, knowing that they have the ability to, rather than paying the tax in retirement,” he said.”

4% participation rate

At the City of Los Angeles Deferred Compensation Plan, 4% of active employees have chosen a Roth option, said Steven Montagna, senior personnel analyst and manager for the $3.5 billion plan. The option was introduced in July 2011.

Mr. Montagna attributed the low participation rates in part to employee concern about what they believe is a complex decision. When participants hear they should consult a tax adviser, “they think this is a big deal and that they need to talk to an expert,” Mr. Montagna said.

His plan has tried to “demystify” the evaluation process, he said. The plan won a 2012 Eddy Award — sponsored by Pensions & Investments — for special projects among public plans for its campaign describing the differences between the traditional 457(b) and the Roth 457(b).

Sponsors, providers and consultants are waiting for comments from the Internal Revenue Service on how to comply with the new law. The IRS “anticipates issuing guidance later this year,” the agency website says.

Robert A. Benish, interim president and executive director of the Plan Sponsor Council of America, Chicago, compared a company providing a Roth option to its offering a health club membership. “It's one thing to provide access, but you can't make people go,” he said.

Although the new law “will provide people with more flexibility, I don't think this legislation will be a magic bullet,” Mr. Benish said.

“There's no reason to believe that this law is going to cause a rush” for Roth conversions, said Howard Gleckman, resident fellow at the Tax Policy Center, Washington, a joint venture of the Urban Institute and the Brookings Institution. “You're asking people to guess what their tax rate will be in 30 years. It's hard for them to figure out if this is a good idea.”

The new law could raise increase the number of conversions, but “it is too soon to tell,” said Alison Borland, vice president for retirement solutions and strategies at Aon Hewitt, Lincolnshire, Ill.

Likely candidates for conversions would be people in the mid-to-high pay levels - in their early 30s to late 40s - “who haven't topped out in their earnings potential,” she said. “This is a group starting to think about the future.” Other candidates would be people who can afford to pay the upfront tax bill.

Available since 2006

Roth options have been available to participants in 401(k) plans and 403(b) plans since 2006 and for participants in 457(b) plans since 2011. In-plan Roth conversions have been permitted for just over two years.

Although the rate of plans offering Roth options has risen steadily, the rate of participation hasn't grown as fast, according to the PSCA.

In its annual surveys of 401(k) plans, the PSCA said the percentage of plans offering Roth options climbed to 49% in 2011 from 18.4% in 2006. Participation was 17.4% in 2011, up from 11.6% in 2006.

Mr. Benish attributes the low take-up level to participants being overwhelmed by an abundance of retirement planning and investing information. “There's so much going on,” he said. “There are so many features.”

Among defined contribution plans for which Vanguard Group Inc., Malvern, Pa., is record keeper, the Roth participation rate was 9% in 2011. The rate was 5% in 2006. The percentage of plans offering the Roth option reached 49% in 2012 representing a steady annual climb from the 12% that offered it in 2006.

Jean Young, senior research analyst at the Vanguard Center for Retirement Research, said the new Roth conversion law could create some additional interest by participants and plans. “I wouldn't expect to see a lot of plans adding the conversion (option) because participant take-up rates are so low,” she said. “It's considered complicated. It won't be high on the sponsors' priority list.”

Among TIAA-CREF's 403(b) plan clients, about one-fourth to one-third offer a Roth option, but “the take-up has been modest,” Mr. Ray said.

Aon Hewitt's Ms. Borland said the biggest impediments for plans providing Roth options include sponsors' concerns about extra administrative work and additional time and effort for employee communication, as well as a relative lack of demand by participants.

Roth options are most popular among younger workers and those in middle-pay ranges, Ms. Borland said. A new participant in a DC plan would be more likely to choose a Roth than would someone who has participated for many years in the traditional 401(k).

According to Aon Hewitt research, 40% of DC plans offer Roth options. Of that group, 29% permit Roth conversions. But the conversion rate is in the “very low single digits,” Ms. Borland said.

In 2011, according to the latest available data, 8.1% of employees contributed to a Roth 401(k) where available, she added. n

This article originally appeared in the February 4, 2013 print issue as, "Don't expect a flood of Roth conversions".