GuidePost - Vol. 2, Issue 1 2006

The GRABot BAG
by Sherrie E. Grabot, CEO

January 2006
Now what? Roth 401(k) rings in the New Year

It's he-eere!

As of January 1, 2006, the new Roth 401(k) is looming on the retirement savings landscape. An employer-sponsored equivalent of the popular Roth IRA (with some differences in the rules), the new plans flip the tax-exempt status of participants' funds from back to front. Participants contribute their earnings to the plan after paying taxes, then can withdraw their funds tax-free at age 59 and a half.

Or maybe not. The President's Advisory Panel on Tax Reform has proposed changes to greatly simplify retirement savings accounts, with an uncertain impact on both Roth and traditional 401(k). And on the other side of the aisle, there has been Democratic opposition to Roth plans, based in part on the thinking that they would benefit affluent savers more than low and middle-income employees - and perhaps help them get around the cap on traditional 401(k) contributions as well.

The new plans present an interesting choice for participants. Anyone facing the decision is in essence betting on their future income tax rate. If you expect your tax rate at retirement to be higher than it is today, going with the Roth 401(k) and paying the taxes now seems a good bet. If you think you'll be in a lower bracket when you retire, you may be better off deferring those taxes with a traditional 401(k). Just look into your crystal ball, do your present value calculations, and sign on the dotted line.

Don't forget that the whole thing might become a white elephant in 2011, if and when the sunset provisions kick in for the legislation authorizing Roth 401(k) plans. For that matter, with even longstanding sacred cows like the mortgage interest tax credit on the table these days, who wants to bet that the entire tax code might be very, very different in 10, 20, or 30 years?

Of course, having even more plan choices is only "exciting" to a minority of participants. Most have too much choice as it is, even within a traditional plan. I expect that for most Americans, trying to estimate their taxes in the far future is almost as painful as paying them every spring.

According to a recent Hewitt study, only 13% of large companies surveyed are “very likely” to offer Roth plans to their employees this year. I expect the rest aren’t going to jump on the bandwagon very soon, either. The main reasons cited? “Administrative complexity, vague guidelines, concerns about lack of use by employees, and difficulties communicating.” That is, the ratio of added confusion to added value is just too high.

First privatization of Social Security accounts (that one really didn’t fly). Now Roth 401(k). What’s next? Don’t get me wrong, I’m all for innovation – that’s what I’ve been doing for most of my career. But I strongly believe any better mousetrap isn’t worth making unless it’s also an easier mousetrap (and easier on the mouse, too).

As nearly anyone in the industry will agree, what employees need to do in larger numbers, and with greater enthusiasm, is very basic: Save more, start early, and invest sanely. The same study reported some encouraging signs that many companies are taking action along these lines:

• 23% are very likely to add automatic enrollment by the end of the year.
• 13% will add some kind of automatic contribution increases.
• 16% will limit or eliminate company stock as an investment option.
• 16% will add online 3rd-party investment advisory services.

Given the sometimes glacial rate of adoption in the world of K plans, (and given they don’t count companies which have already adopted) these are pretty impressive numbers. We’re looking forward to a great year helping with that last item. Now, if only we could light a fire under all the companies who responded “somewhat likely”…

~~ Sherrie