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Despite Limited Appeal to Participants, Some Employers Embracing Roth 401(k)

While retirement industry experts expect the new Roth 401(k) accounts to appeal to a limited segment of the U.S. population, a small percentage of employers are making them available to their employees. In a survey of mostly large employers late last year by human resources outsourcing and consulting firm Hewitt Associates, 13 percent of the respondents said they were "very likely" to begin offering Roth accounts this year and another 21 percent said they were "somewhat likely" to do so. Among those who will: automaker General Motors Corp., which will make them available to more than 140,000 eligible employees beginning this summer.

Authorized by the Economic Growth and Tax Relief Act of 2001 (EGTRRA), Roth 401(k)s debuted this year after the U.S. Department of Treasury and the Internal Revenue Service finally issued final regulations for their use last December. (A summary of the regulations can be found at the Treasury's website at http://www.ustreas.gov/press/releases/reports/roth401k_reg_attch.pdf.) The accounts are much like traditional 401(k) plans but receive different tax treatment. Contributions to a traditional 401(k) are tax deductible, but withdrawals are taxable as ordinary income. Roth 401(k)s work exactly the opposite way; contributions are not tax deductible, but withdrawals are tax free once account holders retire, provided they are over the age of 59 1/2 and have had their accounts for at least five years. Federal law allows workers to contribute up to $15,000 to a 401(k) account this year, or $20,000 if they are age 50 or older. Workers can divide that amount any way they wish between a Roth and traditional 401(k), assuming their employer makes both types available. Many retirement plan providers are developing calculators to help workers make such decisions.

Like Roth IRAs, which were introduced in 1998, Roth 401(k)s will appeal primarily to investors who expect to be in a higher tax bracket in retirement than they are while working. Chris Bowman, vice president of retirement and investors services for Principal Financial Group, an insurance company and retirement plan vendor, says that's a limited audience. "Most people don't save enough for retirement, which means most people will have less income in retirement than they do today," he explains. "That means most people would be better off with a traditional 'k' plan." He estimates that only 10 percent to 15 percent of workers with access to a Roth 401(k) will take advantage of it.

That said, Bowman argues that it would be shortsighted for employers to deny employees access to a Roth 401(k) account, assuming their plan provider is able to handle the administrative details and the employer is prepared to educate employees about how the accounts work. After all, he notes, many of the employees who will want a Roth are likely to be highly compensated and hold key positions-employees, in other words, the employer may not want to alienate by denying them access to a benefit they want.

Some retirement industry experts predict the Roth 401(k) will appeal to an even wider array of workers, however. For example, employees who are concerned that they can't predict what their tax situation will be in retirement may choose to put at least some of their savings into a Roth 401(k). Then, depending on their tax situation after they stop working, they would have the flexibility to draw money from either type of account. Bowman, who's firm caters primarily to small employers, says that by mid-February about 5 percent of the company's plan sponsor clients had requested amendments to their retirement plan documents that would allow them to offer a Roth 401(k), and those requests were becoming more frequent. "I wouldn't be too surprised if we ended up with 50 percent or better in terms of how many put it into their program," he says.

Catherine Collinson, senior vice president for strategic planning with Transamerica Retirement Services, says her firm, too, has seen a high level of interest from smaller plan sponsors, but adds that with the Roth 401(k) regulations finally here, many are now weighing the pros and cons of the accounts before proceeding to offer them. While appealing to employees destined for a higher tax bracket in retirement, she explains, the accounts also will impose additional administrative work on employers. "It's fairly complex in terms of the employer's obligations," agrees Kerrie Richter, vice president of products and marketing for Ameriprise Retirement Services. "You need to update your Summary Plan Descriptions and make sure those get sent to all employees. You have to modify your recordkeeping system to handle the different types of pre-tax and post-tax contributions, and that affects payroll systems and complicates ADP (actual deferral percentage) testing. You've also got to educate employees about the new offerings and update employee access points such as your Website, account statements and call center, where your training needs to be updated. As providers incur costs in these areas, some of that transfers to sponsors, and that's a consideration."

Other employers worry that after they go through all that trouble, Roth 401(k) accounts may disappear anyway. EGTRRA, the legislation which enabled the accounts, is set to expire in 2010 unless Congress intervenes to extend it. While the House has passed legislation that would do just that, the Senate, concerned about its costs, has not; the two chambers are trying to work out their differences on that and other pension reform legislation right now. Retirement plan providers predict that if EGTRRA isn't extended, existing Roth 401(k) accounts and their tax benefits wouldn't disappear. Rather, they expect, workers simply wouldn't be able to make any more contributions to them, nor could workers open new Roth accounts.

Apart from concerns about administrative burdens and the tenuous legal status of Roth 401(k) plans, some plan sponsors worry the accounts will add another layer of complexity to their retirement plans, which could alienate some workers. Research suggests that when people have to make too many decisions about investing in their retirement plan, some throw up their hands and simply choose not to invest at all. "We don't want to go into Roth paralysis," Bowman says.

Lori Lucas, director of participant research for Hewitt Associates, predicts that many employers will take a wait-and-see approach to the Roth 401(k). They'll look at the utilization rates early adopters experience, she says, and if they are strong, and if plan participants aren't being confused by the accounts, more employers will offer them. In addition to watching how General Motors fares, they will also be able to look to a handful of other large employers who have embraced the Roth, including financial services firms Vanguard Group, A.G. Edwards, and Hewitt Associates.

Regardless of how broadly the new accounts are adopted, retirement industry experts don't foresee them having a dramatic impact on the stable value industry. They note that plan sponsors are expected to offer the same investment lineup for their Roth 401(k) accounts that they offer in their traditional 401(k) accounts, and that stable value investments offer the same benefits to investors in either type of account. Managers of stable value assets won't have to do anything special to accommodate inflows from Roth 401(k) accounts; plan recordkeepers will simply need to keep track of whether participants' contributions are allocated from a regular or Roth 401(k) account.

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