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'Fiscal cliff' provision opens door for increased Roth adoption
An increasing number of U.S. employers are planning to add Roth options to their 401(k), 403(b) or other defined contribution plans in 2013, a January 2013 survey by consultancy Aon Hewitt reveals. This comes on the heels of legislation that makes it easier for defined contribution investors to convert balances within their savings plan into Roth accounts.
Unlike traditional 401(k) plans, where employees make pretax contributions and, after retirement, pay income taxes on all distributions, Roth 401(k) contributions are made with after-tax dollars. Funds in the plan grow tax-free, and on retirement no taxes are owed on any distributions.
Previously, converting funds from a pretax to a Roth 401(k) account was limited to money that was already “distributable” without penalty from the pretax plan—typically when an employee reached age 59½ or terminated employment, unless the plan otherwise allowed in-service distributions.
The American Tax Payer Relief Act—the “fiscal cliff” deal enacted in January 2013—includes a provision that “opens the door for employers to allow expanded in-plan conversions, but it’s not a requirement,” said Patti Balthazor Bjork, retirement research director at Aon Hewitt. “However, it makes the Roth conversions more attractive for employees, so there will likely be increased interest and incentive for employers to offer them.”
The consultancy’s survey of large U.S. employers (those with more than 1,000 employees) revealed that:
“While employers have steadily been adopting Roth features in recent years, the new law, along with a better understanding of Roth by both participants and companies, will encourage more plan sponsors to add these options in the near-term,” Bjork said.
Roth Participants Boast a Higher Savings Rate
As of the end of 2012, 37 percent of defined contribution plans in the U.S. administered by Fidelity Investments, one of the largest plan service providers, offered a Roth savings option, up from 12 percent five years earlier.
Younger investors tended to use Roths the most; 10 percent of participants in their 20s contributed to this option vs. 6 percent overall.
Young participants may be well-positioned to benefit from Roth due to their long investment horizon and the likelihood they will be in a higher tax bracket on retirement. A distribution from a Roth 401(k) is tax free and penalty free, provided a five-year holding requirement has been satisfied and one of the following conditions is met: age 59½, disability or death.
Roth contributors also boasted a higher savings rate, deferring an average of 11 percent of salary. When factoring in employer contributions, Roth participants show a total savings rate of 15.3 percent, more than 3 percentage points higher than the overall average.
Nearly six out of 10 (59 percent) of Roth participants use a tax diversification strategy by saving a portion in a post-tax Roth 401(k) and a portion in a pre-tax traditional 401(k) option.
Stephen Miller, CEBS, is an online editor/manager for SHRM.
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