Some retirement plan advisers are using the prospect of tax reform in the Trump administration to promote the idea of a Roth 401(k) to employers and their employees.
Lower income tax rates are a prominent feature of tax plans presented by both President Donald Trump during his candidacy and congressional Republicans, and some advisers argue paying a reduced upfront tax would make Roth more attractive versus traditional pre-tax contributions.
“I'm projecting that we are going to get a tax reduction, and I think if we do it will make the Roth even more appealing,” said Chad Larsen, president and chief executive of MRP, a registered investment adviser based in Denver with more than $3 billion in retirement plan assets.
If income tax rates come down, according to Mr. Larsen, taking a pre-tax deduction today may be less appealing long term for plan participants than making Roth deferrals and paying tax now.
“As far as our [participant] education team and our firm, that's one of the things we'll be stressing this year. We need to be much bolder on getting people to consider the Roth,” Mr. Larsen said. “I wouldn't hesitate to tell an employee group that's exactly what they should be doing.”
Although Mr. Trump's first executive actions in office indicate a focus on non-tax issues, such as health care and immigration, Washington observers believe tax reform is highly likely to be taken up this year, especially since Republicans on Capitol Hill are
making a push for it as well.
Mr. Trump earlier this week reiterated his campaign promise to cut income taxes.
“We are going to be cutting taxes massively both for the middle class and for companies — and that's massively,” he said Jan. 23,
according to Politico.
Source: Plan Sponsor Council of America
The availability to make Roth deferrals in 401(k) plans has increased markedly over the past decade. Sixty percent of 401(k) plans currently offer a Roth feature, up from 18% in 2006, according to the Plan Sponsor Council of America.
Participants, however, haven't latched on to the concept. In plans that offer it, only 20% of participants make Roth contributions.
“I think people will be doing more and more Roth accounts due to this,” Anthony J. Domino, Jr., managing principal at Associated Benefit Consultants, said of tax reform.
Mr. Trump has
proposed three tax brackets — 12%, 25% and 33% — as opposed to the current
seven, which range from 10% to 39.6%. The rates mirror those put forth in a tax proposal
published last year by Republicans in the House Ways and Means Committee.
“The observation that a lower tax bracket changes the playing field is correct,” Mr. Domino said. “We're starting to work that into our conversations with people about Roth.”
Mr. Larsen also said lower taxes presents an opportunity to discuss the benefits of doing a Roth conversion, although conceded not everyone will necessarily have the money to pay the requisite tax.
“There are people that have that capability, and that will be a very compelling thing for them to look at,” he said. Only 36% of 401(k) plans offer an
in-plan Roth conversion, according to PSCA data.
Mr. Domino indicated the prospect of tax reform presents an opportunity to get employers to include Roth as a plan feature, but said incorporation of Roth into participant discussions isn't being done on a “wholesale basis.”
“I don't think that Roth is such an absolute truth that everyone has to do it no matter what,” Mr. Domino said.
He, like other retirement plan advisers, believes Roth makes sense for a few distinct groups of participants, and shouldn't be driven purely by a lower tax bracket.
Typically, young employees who pay a low tax rate now but believe it will increase in the future, as well as employees who've accumulated significant retirement assets and need to diversify their sources of retirement income, are two groups who'd best qualify for Roth, according to Aaron Pottichen, retirement services practice leader at CLS Partners.
Mr. Pottichen says his firm, which is based in Austin, Texas, “advocates like crazy” to make Roth available for employees, but whether they contribute Roth or pre-tax should be dictated by their retirement goals rather than a low tax rate.
“You need to accumulate more money right now. Roth doesn't help people accumulate more money now,” Mr. Pottichen said. “It's an accumulation game, not a taxation game.”
