It's clear taxes will be center stage in the presidential race, which makes it all the more important for plan sponsors to make sure they have investment options that hedge tax uncertainty — no matter who ends up in the White House.
One choice that might hedge against rising income taxes is a Roth 401(k). Plan sponsors that don't offer a Roth 401(k) should add the feature to their defined contribution plans as an option for those participants who might want to choose to have withdrawal on a tax-free basis, while preferring to contribute on a taxable basis.
Those that already include the choice ought to bolster participant education about its potential advantages to improve retirement income outcomes.
Increased taxes, especially income taxes, would threaten to undermine retirement income security. They would take more out of the withdrawals that participants make from their defined contribution assets once they retire, which become subject to income tax rates.
To step up retirement readiness programs for participants, plans sponsors should provide the Roth 401(k) option — or Roth 403(b) or Roth 457. They should also provide materials and guidance so they can make informed decisions on the potential advantages of Roth plans and their tax consequences compared with a conventional 401(k).
Although a Roth feature adds complexity and costs for a plan sponsor, that assistance can help active participants guide their contribution decisions and determine whether they would prefer contributing to their plans on a tax-sheltered basis and paying income taxes on withdrawals in retirement, or contributing on a taxable basis and enjoying income-tax-free withdrawals in retirement.
Offering a Roth would also allow participants to practice diversification of tax outcomes, putting some contributions into a conventional 401(k) and the rest into a Roth 401(k) to hedge the uncertainly of the tax impact on both contributions over the active service of participants and withdrawals in retirement.
An increase in income tax rates could jeopardize achievement of a participant's retirement income objectives, both by reducing the money available for contributions toward the retirement programs, and by reducing the after-tax income in retirement.
Plans sponsors must address the implications of tax issues as part of participant education efforts. That guidance should also include the implications for defined benefit plan participants and choices they have to reduce the income tax impact in retirement on their pension benefits, whether received in annuity payments or a lump sum.
Some presidential candidates, as well as the Obama administration and many in Congress, are hungry for more revenue to finance new programs, even though the federal government cannot pay for its existing programs, so the impulse to raise new tax revenue is strong.
Congress and the Obama administration have recently sought to undermine retirement plan contribution incentives.
President Obama's budget proposal, released in 2014, and a tax-code restructuring proposed by Rep. David Camp, R-Mich., would have limited tax-advantaged retirement contributions and undermined retirement savings incentives.
But by putting forth the ideas, they laid the groundwork for identifying a new potential source of federal revenue for other administrations and Congresses.
Also, a Roth or conventional 401(k) won't protect participants from other types of tax hits.
Sen. Bernie Sanders last year proposed a wealth tax, an idea he is carrying into his campaign for the Democratic nomination for president.
But anyone urging new or increased taxes should bear in mind the adverse impact on retirement income security, as well as on the overall economy and investment markets.
Defined contribution plans, which are often the only workplace-sponsored retirement program for participants, have been the subject of concern about their ability to accumulate adequate assets to meet lifetime retirement income goals, especially for lower-paid participants.
Adding taxes that potentially could take a bigger bite of those assets undercuts retirement objectives. Plan sponsors ought to speak out to warn about the potential consequences.
An increasing number of plan sponsors are making available the Roth feature to their 401(k) plans, according to an Aon Hewitt biennial report, “2015 Trends & Experience in Defined Contribution Plans” that the investment consulting firm plans to release in November. Some 58% of plans in the survey of 367 employers it surveyed for the report offer 401(k)s for employees, while 48% offer after-tax contributions, up respectively from 50% and 42% in 2013, its most recent previous survey.
Some 33% of the plans surveyed offer in-plan Roth conversions, up from 27%. The America Taxpayer Relief Act, passed by Congress in 2013, allowed in-plan conversions.
More sponsors need to step up offering Roth conversions to enhance participant ability to improve retirement income outcomes.
Many participants who might consider converting to a Roth 401(k), or other types of Roth defined contribution plans, would have already begun accumulating assets before the Roth feature became available to defined contribution plans. Rob Austin, Aon Hewitt director of retirement research, estimates 10% to 12% of participants who have access to it in their workplace defined contribution plans use the Roth feature.
“We've seen this grow overtime,” as participants “catch onto the Roth concept,” Mr. Austin said. A Roth 401(k) or other Roth defined contribution plan isn't necessarly the choice for all participants. The Roth feature, Mr. Austin noted, tends to attract younger participants, generally in low marginal income tax brackets and having the longest time horizon until retirement, and those with annual salaries in a range of between $40,000 and $80,000.
Even though the upfront income tax payment under a Roth 401(k) or conversion yields gains immediate revenue to the federal government unlike a conventional defined contribution plan, nothing in the Roth law prevents a future Congress driven to find new revenue sources from curtailing or ending the Roth feature, including for existing participants, to capture additional income taxes upon withdrawal.
Defined contribution plan participants face enough hurdles trying to build retirement assets. Putting more obstacles in their path through increased taxes will put their retirement income outcomes at even greater risk. n
