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Defined Contribution

Lack of education cited in low takeup of Roth plan option

Marina Edwards said participants aren’t getting enough education on Roth 401(k) options.

Many retirement savers aren't taking advantage of a Roth feature in 401(k) and other DC plans, even though more sponsors are offering one.

Participants often don't understand how the Roth option works, or what its tax implications are, consultants, researchers and record keepers said. They added that plan executives could do a better job of providing information about the Roth approach.

"The biggest culprit to a lack of takeup rate is that participants don't know how to take action," said Marina Edwards, a Chicago-based consultant for Willis Towers Watson PLC. "If they don't understand it, they don't use it."

Sponsors need to offer "a higher level of communication" to overcome participant reluctance, inertia and confusion, said Diana Awed, the Owings Mills, Md.-based head of retirement product and marketing for T. Rowe Price Retirement Services.

"So much of our retirement system is predicated on tax deferral," said Ms. Awed, referring to the taxing of distributions from a traditional DC plan rather than the taxing of contributions to a Roth plan. ​ "Roth is more complicated. There are no simple rules of thumb." (Although available most often in 401(k) plans, the Roth feature also can be used by participants in 403(b) and 457(b) plans).

Martin Schmidt's clients aren't clamoring to offer Roth options. "I'm not seeing a groundswell of interest," said Mr. Schmidt, principal at HS2 Benefits, an investment and benefits consulting firm in Chicago. "It's more a case of providers bring it up and sponsors say it's a nice feature to have. Utilization is minimal."

Participation rates among Vanguard Group Inc. clients have inched up in recent years.

Among DC plans that offer a Roth option, 13% of participants used it last year vs. 10% in 2012, according to Vanguard's annual survey of client behavior, published in June. The survey covered 1,900 plans — mostly 401(k) — and 4.4 million participants.

Those rates pale in comparison to the percentage of plans offering this feature — 65% last year vs. 49% in 2012 — according to the company's "How America Saves 2017" report.

Not waiting for Congress

Of course, Roth utilization numbers could change dramatically if Congress tries to force plans to offer Roth DC plans or hybrid Roth-traditional plans as part of a tax-code rewrite. However, interviewees said they are focusing on the here and now rather than on the maybe of congressional action.

"You have to actively choose" to take a Roth plan vs. a traditional plan, said Jean Young senior research analyst at Vanguard's Center for Investor Research, Malvern, Pa. "People have to be farsighted to give up a tax advantage today" via the traditional DC plan.

Participants contemplating a Roth 401(k) approach must keep track of many moving parts in their personal finances, according a Willis Towers Watson report issued last year.

Making contributions to either plan "can be tricky for employees because of the interplay between Social Security benefits and taxes at retirement," the report said. Different contribution rates and employee income levels are among the factors that determine which strategy is best.

For traditional 401(k) plan investors, the report also warned of the "tax torpedo," a circumstance in which a person could be pushed into a higher tax bracket as Social Security benefits are phased in as taxable income, adding to taxable income from retirement plan distributions.

If the participant had invested some 401(k) money into a Roth account that was later rolled over into a Roth IRA, the participant could "mitigate" the impact of the tax torpedo by taking distributions from the Roth IRA because those funds "do not trigger the phase-in of additional Social Security benefits as taxable income," the report said.

Tax calculations for the Roth 401(k) vs. the traditional 401(k) "are unique to each individual," said Ms. Edwards of Willis Towers Watson.

Researchers and record keepers said Roth plan participants have higher savings rates than their traditional DC plan peers — a finding that suggests they are more disciplined in "long-range thinking," said Vanguard's Ms. Young. "It's hard to get people to have that future vision."

Alight Solutions found Roth DC plan participants have an average savings rate of 9.7% of annual pay, or 2 percentage points higher than those in traditional plans, according to a July report. The report looked at 125 clients' plans, mostly 401(k) plans, with more than 3 million participants. "Amplifying this difference is the fact that contributions made on a Roth basis are worth more than pre-tax contributions because they will not be reduced for taxes upon withdrawal," Robert Austin, Alight's Charlotte, N.C.-based director of research, wrote in a separate commentary in August about the report's findings. When participants switch to Roth, "they generally increase their savings rates," Mr. Austin wrote. Alight also analyzed data for approximately 25,000 workers "who decided to start saving on a Roth basis in 2016," and it found that "most of them increased their 401(k) contributions," he wrote.

In 2015, the average savings rate for non-Roth participants was 8.2%, but the rate jumped to 10.6% in 2016 when they switched to a Roth approach. "And it wasn't just a few people driving the average up," Mr. Austin wrote. "Two-thirds of people increased their savings rate when they made the change."

Popular among millennials

Among Alight Solutions clients, participants' use of Roth DC plans is modest, according to the July report. The percentage of participants has crept up to 13% in 2016 vs. 10% in 2012.

"It takes a while to catch on," Mr. Austin said in interview, predicting that as more plans add Roth options, more participants will take advantage.

Alight's research shows millennials are the most willing to use a Roth strategy. That's no surprise because the younger workers have lower salaries and are hoping to lock in a lower tax rate than they would pay in retirement, Mr. Austin said.​