The “Rothification” of 401(k)s

Anyone who follows KCS knows that we prefer defined benefit (DB) plans relative to defined contribution (DC) plans for a significant percentage of our workforce.   Sure, there are some workers who can handle the funding, management, and distribution of a DC plan, but it is a small minority of participants.  However, since DC plans are quickly becoming the only retirement option, we, of course, want these programs to be the very best that they can be.

Congress, as part of tax reform, considered significant changes to 401(K)s.  Although legislative changes do not seem likely at this point, there are significant debates raging as to how to make the tax reform package revenue neutral, which may force both branches of Congress to reconsider their options.

Forcing individuals to adopt a Roth option for some, if not all, of their future 401(k) contributions is not going to help alleviate the growing U.S. retirement crisis.  A wonderful report has recently been released by the Center for Retirement Research at Boston College.  The report, titled, “Dodged a Bullet? ‘Rothification’ Likely to Reduce Retirement Saving” by Alicia H. Munnell and Gal Wettstein does a terrific job of comparing and contrasting the pre- and post-tax benefits of traditional and Roth 401(k)s. In the report they speculate that “many, especially those who have lower incomes or are cash-strapped, may overreact and save much less.”

It appears that 401(k) participants favor the immediate tax savings as opposed to waiting years for the tax benefit to kick in.  According to Vanguard, nearly 70% of all of their 401(k) participants are provided with an opportunity to invest in a Roth option, yet only 9% actually use one. Furthermore, when polled, 80-90% of plan sponsors believe that eliminating or reducing pre-tax contributions would have an adverse effect on retirement savings.

As mentioned above, we are already facing a retirement crisis in this country. Let’s not exacerbate the situation by imposing more hurdles.  Let’s spend the necessary time fixing traditional 401(k)s to make them more like retirement vehicles than glorified savings accounts.

 

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