Every day, employees meet with pension record-keeper advisers and have a typical discussion about their 401(k), 403(b) or 457 defined-contribution plans:
Employee: "I can only afford to contribute $400 per paycheck to my 401(k) plan."
Adviser: "Did you know that if you contribute $600, you will save about $200 in taxes, meaning $600 will be growing for you for only a $400 reduction to your paycheck?"
Employee: "That sounds great, but what about this Roth 401(k) option I keep hearing about?"
Adviser: "I can't give you tax advice, but I can tell you that it really comes down to whether you want to pay your taxes now or would you rather postpone those taxes to your retirement years? Let's start reducing your taxes today, and you can run this by your tax adviser and change to a Roth later."
For a large portion of participants in the DC market, the Roth option might be a better tax solution than a traditional DC plan. However, unless an employee's financial adviser, financial planner, CPA or tax preparer specifically raises the question of whether a Roth DC option is available to the employee, this important decision, and the loss of thousands of dollars in tax savings, very likely falls through the cracks.
Vanguard recently disclosed that between 2013 and 2017, the percentage of plans offering Roth 401(k)s in Vanguard's full-service business increased from 52% to 68%, while the portion of participants choosing the Roth deferral actually declined between 2016 and 2017, from 13% to 12%.
(More: Don't forget tax diversification)
One of the causes of the
lower market penetration of Roth plans might be the record-keeper advisers' assets-under-management compensation model. The representative above and his company are juggling a conflict of interest issue in that they reap 50% greater earnings on $600 in AUM in a traditional DC plan than they do on $400 in AUM in a Roth plan.
Extrapolate that small profit for this one employee by all the other employees of the same company, and then multiply this company's personnel by the thousands of other DC plans serviced by dozens of record keepers, and the billions of dollars in extra fee revenue generated by traditional DC plans might be incentivizing the lack of genuine Roth-versus-traditional comparisons.
Some financial service companies' online Roth/traditional comparison calculators even steer toward traditional DC plans by defaulting to an extremely low retirement tax bracket and assuming that participants calculate, segregate and invest their tax savings float from a traditional DC plan until the account is distributed. Neither a 15% retirement tax bracket nor employees having even a vague idea of what their actual annual tax savings are is a realistic assumption.
The tax questionnaires of most CPAs, tax preparers and online tax software companies do not ask whether a DC Roth or traditional option is available. Financial advisers, financial planners, CPAs and tax preparers are perfectly positioned to add value to their practices by specifically asking their clients whether they have a choice between a Roth or traditional plan, and then guiding them to the best choice tax-wise.
If expertise is not inserted by these fiduciaries, the inertia caused by the AUM compensation model means millions of participants may actually be paying fees for bad tax advice and missing out on billions of dollars of Roth plan tax savings.
(More: Are record keepers friend or foe to 401(k) advisers?)
Lou Barberini is a CPA and retirement plans analyst at Nich Capital Partners.
