What a $2,400 pre-tax cap and ‘Rothification’ could mean for 401(k) plans

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Republicans have hinted at plans to reduce the amount of money employees can contribute pre-tax to their workplace 401(k) plans. Some industry insiders believe that one idea, a $2,400 pre-tax cap, if implemented would likely have employers looking for alternative ways to help employees save for retirement. At a minimum, it would force employers to rethink their retirement savings communications.

If a low cap goes into effect, employers should start thinking about what they will do in response, says Robyn Credico, DC consulting leader for Willis Towers Watson’s defined contribution consulting practice. That could mean offering a higher match to make the plan more attractive or canceling their plan and just giving people additional money in their paycheck, she says.

However, plan sponsors should also consider the alternative: that Congress will raise contribution limits. If that’s the case, employers could spread out their matching contribution to encourage people to save up to the new limit, Credico adds.

There also has been talk about Rothification of workplace plans, meaning that employees can save up to $2,400 pre-tax and then the rest of their retirement contributions will go into an after-tax Roth account.

Bob Melia, executive director of the Institutional Retirement Income Council, says forced or partial Rothification is disruptive to the market in that it’s likely to cause confusion and could negatively affect savings behavior.

“We want to preserve the tax-deferred status of retirement savings. Disruption would be hard to work through. We’re not naïve here. If it goes through, and you can’t stop that, it is time to do an analysis: think strategically and make the most out of the required change to help employees and help them get to a higher state of retirement readiness,” Melia says.

If employers don’t currently offer a Roth option as part of their 401(k), they might want to start looking into it, he says. Employers should also consider educating employees about what investing in a Roth means for them. If their workforce is made up of young professionals who have lower salaries now, but expect to make more later on, paying taxes on their money now is a good idea. For those in a higher tax bracket, but who expect to be in a lower tax bracket in retirement, Roth may not be such a good idea for them, Melia says.

Thorough communication
Employers should also look at the different tools their retirement plan vendors are offering and make sure they adapt to any tax reform changes. Will their retirement calculators reflect that a person needs to save less because their savings have already been taxed ahead of time, and how do they communicate that to employees?

“If you only had a Roth it doesn’t mean people wouldn’t save,” says Credico. Employers could still automatically enroll people into the plan at 3% to 6% of their earnings. She doesn’t believe that the opt-out rates would be any higher than they currently are for traditional employer-sponsored 401(k) plans.

What would change is how employers talk about the benefits of saving for retirement. If the pre-tax option is off the table, discussions would have to center around the importance of saving in general, she says.

Regardless of what happens with tax reform, the reasons behind offering a workplace retirement plan don’t change, Melia says. Having some money in retirement that hasn’t been taxed and some that still needs to be taxed “may not be so bad. It is a way to not have all of your eggs in one tax bucket,” he adds.

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Retirement benefits Retirement readiness Retirement education Law and regulation