Plan sponsors benefit when employees make really good financial decisions.
Numerous industry studies have shown that “when employees are under financial stress or feel uncomfortable about their current and future financial life, that uneasiness, that stress, spills over into their work life, so what employers are finding is that enabling employees to find a stable financial situation makes them more productive. They show up at work more often with lower levels of stress. They take less sick days and are more engaged,” says Kevin Wagner, senior retirement consultant for Willis Towers Watson.
Roth 401(k)s have gained in popularity the past few years, with more than 50% of large employers offering them to plan participants, yet only 10% of employees are using them, he says.
Roth 401(k) contributions can be one of the most tax-effective ways for employees to save for retirement, according to Willis Towers Watson.
“With Roth 401(k) contributions, workers make contributions using after-tax dollars and are able to take tax-free withdrawals at retirement. More importantly, Roth contributions can offer tax diversification for many retirees as they begin to take pensions, employer-match contributions from regular 401(k) plans and other taxable income. And unlike with regular 401(k)s and Social Security, Roth 401(k) contributions are not subject to minimum distribution requirements after age 70½ if they are rolled over to a Roth IRA,” according to Willis Towers Watson.
Tax planning in retirement is a topic that barely gets mentioned until it is almost time for a person to retire. The vast majority of employers offer 401(k) plans, whereby the plan participant’s money goes in pre-tax and is taxed upon withdrawal. The beauty of a traditional 401(k) is that the person taking advantage of the plan has lower taxable income while they are working since the money deposited into retirement savings goes in before taxes are taken out. What can be a negative is that those monies are taxed when they are withdrawn, which could be at a higher tax rate than when the money was initially invested.
Quote"I’m not a prognosticator where taxes are concerned, but likely they will be higher in the future."
“If tax rates are going up over time [and] I’m not a prognosticator where taxes are concerned, but likely they will be higher in the future,” says Wagner. “By paying today instead of the future, you pay lower overall taxes.”
Adding money into a Roth also gives participants tax diversification.
“Having money both in taxable and tax-free accounts enables the employee or user to have more flexibility in how they use these amounts. If the tax rates go up over time, the value of that will go up substantially,” he says.
“When employees bypass Roth 401(k) contributions, they unnecessarily narrow their tools for tax-effective retirement savings. For some, using distributions before age 65 may enable qualification for healthcare subsidies under the Affordable Care Act. Roth contributions can also help some retirees avoid the tax torpedo, which can increase a retiree’s marginal tax rate based on the tax phase-in on certain Social Security benefits,” says Wagner.
The tax torpedo happens when people claim their Social Security benefits too early and subsidize with their IRA monies. That puts them in a higher provisional income bracket, meaning they will pay more in taxes. If someone instead takes more IRA money out when they first retire and delays their Social Security payments until a later date, in the end, they will pay less in overall taxes in retirement because only half of Social Security benefits are taxed and at a lesser rate than IRA benefits.
So what can employers do to encourage employees to consider a Roth 401(k) option?
Do a better job of communicating program features and benefits clearly and regularly, Wagner says. Every employee is different so plan sponsors should segment employees and identify their needs based on life stages and other characteristics, Willis Towers Watson says. Any communications about the Roth 401(k) should be tailored to these different segments and the messages should be short and actionable.
Quote“When employees bypass Roth 401(k) contributions, they unnecessarily narrow their tools for tax-effective retirement savings."
Plan sponsors should try to get more interactive in their educational approaches, by adding in mobile apps and digital technology that will engage employees around retirement topics.
Modeling tools can also help employees better understand their retirement plan options, especially if they include total estimated retirement income, pay growth, inflation, tax effects and health care costs, the company says.
Plan sponsors should also come up with a way to monitor how employees are doing financially to make sure they are on track for retirement, advises the firm.
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