To Roth or Not to Roth
On January 1, 401(k) and 403(b) plans could allow their participants to make deferrals on a Roth basis. That means that, if the plan permitted, participants could make their deferrals on an after-tax basis, rather than before-tax.
At first blush, you might ask why anyone would want to pay taxes on their deferrals to a 401(k) or 403(b) plan. However, the law provides substantial advantages--to the right people--if they make Roth deferrals. Those substantial advantages are primarily that, when the accounts are ultimately distributed, both the principal and the earnings will be tax free to the participants.
Interestingly, if a participant is in the same tax bracket at retirement as he is today, Roth and regular deferrals produce exactly the same result. On the other hand, if you believe that tax rates are going to increase in the future and/or that you will be in a higher income tax bracket at retirement, then Roth deferrals make a lot of sense.
Also, if a participant already has a large traditional 401(k) account, it could make sense to contribute on a Roth basis in the future, in order to "hedge" your bet on future tax rates and to have the flexibility to make taxable and non-taxable distributions in retirement, based on tax considerations.
Finally, if the Roth 401(k) account is rolled over into a Roth IRA, the minimum required distribution rules would not apply, that is, participants would not have to start taking distributions at 70½. That provides flexibility for estate planning and financial planning.
With that in mind, which employers should seriously consider offering a Roth feature?
First and foremost, organizations with a large number of highly paid people should almost certainly allow for Roth deferrals. That would include investment management firms, medical groups, accounting firms, law firms, consulting groups, some technology businesses, and so on. And, that is doubly true for organizations that have high-paid younger employees.
It should also be considered for organizations with financially astute employees. That could include, for example, financial services companies, brokerage firms, banks, pension administration and actuarial firms, insurance organizations, and so on. The analysis required to make an intelligent decision about Roth deferrals is somewhat complicated. Employees at those types of organizations will probably be better suited to make good decisions.
The moral to this story is that Roth can be very valuable to some people, but much less so to others. In fact, in some plans (for example, plans with low average account balances), it offers little value, but substantial complexity.
However, where it fits, it can fit exceptionally well. Plan sponsors should look at their workforce and their plan, and evaluate the Roth opportunity in that context.
© 2006
Reish Luftman Reicher & Cohen. All rights reserved. THE REPORT TO PLAN SPONSORS is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish Luftman Reicher & Cohen does not warrant and is not responsible for errors or omissions in the content of this report.
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