Pros and cons of adding Roth Option to 401K Plan

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Scott6647
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Scott6647 »

livesoft wrote:I think I was just labeled arrogantly ignorant. :)
I don't see where anyone labeled you as arrogantly ignorant.

However, the points you made were challenged. That seems to be an appropriate thing for a discussion board.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by livesoft »

Oh, I don't mind either way. Discussion is good.

So is it better to benefit 2% of employees and hurt 20% of employees? Or is it better to hurt 2% of employees and avoid hurting 20% of employees?
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Lynette »

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GoldenFinch
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by GoldenFinch »

livesoft wrote:Oh, I don't mind either way. Discussion is good.

So is it better to benefit 2% of employees and hurt 20% of employees? Or is it better to hurt 2% of employees and avoid hurting 20% of employees?
So (pleading genuine ignorance) how are any employees hurt? Are fees higher?
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Clever_Username »

livesoft wrote:
Clever_Username wrote:Why would a higher income benefit more from a Roth option than a lower income employee?
I'm not sure what you mean by "lower income"? Did you mean my "in-between income" that I mentioned?
I think I'm more confused why the executives (who presumably have high salaries) would benefit more from the Roth option than employees who make less than they do, but are still able to contribute.
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Scott6647
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Scott6647 »

livesoft wrote:Oh, I don't mind either way. Discussion is good.

So is it better to benefit 2% of employees and hurt 20% of employees? Or is it better to hurt 2% of employees and avoid hurting 20% of employees?

If you truly don't care there is no need to comment on it or act as if you have been personally attacked.

Here is a question-

In 1996 the lowest tax bracket was 15% for inflation adjusted $58,589 and then 27.5 percent to inflation adjusted $141,023. Both spouses social security and RMD would put you into a 27.5 percent bracket quickly.

If taxes reverted back to this level (which were historically lower than average) would it change your opinion on the percentage of people that would benefit from a Roth at today's lower rates? It would certainly change the percentage of people it would be advantageous to if they were accumulating at current tax rates.

Why are you convinced that today's tax rate will continue for a 35 year horizon?

The decision of a Roth vs a traditional 401k is a complicated one for many reasons. But an unfounded belief in tax rates remaining the same for any period of time is an assumption that has no basis in fact.

If in 35 years tax rates remain exactly the same I will come back to this thread and tell you that you were correct. If they change before that time I look forward to hearing the same from you.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by livesoft »

Scott6647 wrote:Why are you convinced that today's tax rate will continue for a 35 year horizon?
Quite a lot of income is not taxed, so I do not believe that going only by published tax brackets is reality. Yes, tax laws change. Yes, the tax rate could be higher in the future, but deductions could be more resulting in lower taxes. Who knows?

I do know that I am able to shelter a significant fraction of my income and will continue to be able do so. I will be able to convert the bulk of my traditional 401(k) money to a Roth IRA while in a lower tax bracket than when I was contributing. So I am not against Roth IRAs at all, but intend to take advantage of them.

Furthermore big changes in tax laws are a huge political undertaking which helps dampen any changes for folks in the middle ranges.

And to be fair, let me ask this: Why are you convinced that today's tax rates will go up over the next 35 years?
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livesoft
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by livesoft »

Clever_Username wrote:
livesoft wrote:
Clever_Username wrote:Why would a higher income benefit more from a Roth option than a lower income employee?
I'm not sure what you mean by "lower income"? Did you mean my "in-between income" that I mentioned?
I think I'm more confused why the executives (who presumably have high salaries) would benefit more from the Roth option than employees who make less than they do, but are still able to contribute.
Mid-level employees will tend to have mid-level expenses in retirement. Their income will go down in retirement, but some expenses will go away. For instance, they will not pay Social Security and Medicare taxes. They may not pay a mortgage if they own a home. The kids will be out of the house and possibly out of college. Thus, they will not need to withdraw as much money from retirement accounts to live. That way, they will not have as much taxable income and will be able to not be in the highest tax brackets. They should be able do some Roth conversions while in lowest or the same tax brackets as when working. They will have to plan a little bit though.

Folks in the 40+% tax brackets tend to (but not always!) have large taxable accounts and deferred compensation arrangements. In retirement, the income from dividends and payouts from retirement plans will fill up the lower tax brackets and they will get no benefit from the 0% LT capital gains tax rate nor the 15% LTCG tax rate. So in order to avoid the large taxes on gains in a traditional 401(k), they should consider a Roth 401(k).

The wiki has some good information on this: http://www.bogleheads.org/wiki/Traditional_versus_Roth and especially the sections about "Tax risk" and "If you can max out".

There is also this thread on paying ZERO income taxes for the mid-level folks: viewtopic.php?t=87471 Very high income folks probably will not be able to make use of the strategies in that thread. An interesting outcome of that thread was that folks who work too long at a high income did not do better than folks who retired early because those that worked longer had higher taxes on their higher income and were left with less to spend.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by dodecahedron »

livesoft wrote:
And to be fair, let me ask this: Why are you convinced that today's tax rates will go up over the next 35 years?
I am not the person you asked, but leaving politics out of it, I expect the implicit tax rate on my AGI will go up in the future, simply because of SS and Medicare IRMAA issues, not to mention that senior citizen property tax breaks are based on Federal AGI.

As a semiretired person, I would much rather recognize income now, in my early 60s, before SS, Medicare, and senior property tax breaks become an issue. Plus my filing status will likely get worse and worse (currently Qualifying Widow, then expect to be Head of Household with a dependent for a year or two, then eventually single no dependents.) I also expect to lose tax breaks for higher ed expenses in a few years and I won't be able to deduct my HSA contributions once I hit 65.

So there are lots of reasons why people may reasonably expect their marginal tax rates to go up in the future that have zero to do with politics. (Other folks may have reduced deductions due to paying off their mortgages and/or downsizing, resulting in less homeowner deductions.)

So I max my Roth 403b *AND* I max my Roth IRA and I do some Roth conversion as well. I am really shocked at how low my current tax rates are, but it is not a situation I expect to continue in the future.

As they say, "Make hay while the sun shines!"
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by livesoft »

dodecahedron wrote:So I max my Roth 403b *AND* I max my Roth IRA and I do some Roth conversion as well. I am really shocked at how low my current tax rates are, but it is not a situation I expect to continue in the future.
Yes, of course. But you probably fit in the category that you don't need to work at all. :)
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Scott6647
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Scott6647 »

livesoft wrote:
Scott6647 wrote:Why are you convinced that today's tax rate will continue for a 35 year horizon?
Quite a lot of income is not taxed, so I do not believe that going only by published tax brackets is reality. Yes, tax laws change. Yes, the tax rate could be higher in the future, but deductions could be more resulting in lower taxes. Who knows?

I do know that I am able to shelter a significant fraction of my income and will continue to be able do so. I will be able to convert the bulk of my traditional 401(k) money to a Roth IRA while in a lower tax bracket than when I was contributing. So I am not against Roth IRAs at all, but intend to take advantage of them.

Furthermore big changes in tax laws are a huge political undertaking which helps dampen any changes for folks in the middle ranges.

And to be fair, let me ask this: Why are you convinced that today's tax rates will go up over the next 35 years?
We are reaching some common ground. We both admit that neither of us know what future tax rate or deductions will be.

If you are closer to retirement than I future tax rates may not be as big of a concern for you as they are for me.

Changes in tax rates that are big enough to impact retirement planning have happened quiet often over the past 35 years. Just off the top of my head 1) the Reagan tax cuts in his first term 2) the Reagan tax changes in the second term, including indexing tax rates and expemptions to inflation, as well as some rate increases and some decreases 3) George Herbert Walker Bush tax increases 4) Bill Clinton's tax increases (a big one with retirement due to the changes of how social security is taxed 5) George W Bush tax cuts 6) Obama's tax bill which made some of George W. Bush's decreases permanent and increased other rates. In addition every president since Reagan has changed the capital gains tax rates to some degree.

As mentioned I have no idea if taxes will increase but here would be my argument for why they might 1) the national debt continues to increase 2) rates are at near historic lows 3) health care cost are increasing again which will effect obamacare subsidy amounts significantly unless changes are made. 3) economic growth remains at a slow pace which will limit the ability for governmental tax revenue increases to raises in the rates. 4) we have passed the point where increasing taxes only at the highest brackets can provide enough revenue for government spending projections.

As previously mentioned I hedge and contribute to both traditional and Roth. In addition There are numerous other reasons besides fear of tax rates increasing that make the Roth attractive in many situations.

Who knows what happens- maybe after you convert over to a Roth IRA the United States changes to a national sales tax or value added tax and you will get nailed with taxes on your previously taxed assets. Not the most likely scenario but who would have thought we would have capital gains rates like we saw in the George w. Bush administration when there were cases that you would have been better off with a long standing taxable account.

The arguments that most people will be taxed at a lower rate in retirement is most likely applicable to people retiring soon but it is unfounded looking forward as no one knows the future rates and deductions.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Silence Dogood »

livesoft,

Are you against the Roth 401k option in all cases or are you open to the idea that it could sometimes be good to have as an option?
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by livesoft »

I listed ways the Roth 401(k) would be OK:

1. All low-income employees.
2. All very-high-income employees.
3. A free CFP to help employees determine which would be better for them.

Even in your lowish-income, part-time job, the consequences of not having access to a Roth 401(k) are minimal. The damage to you would seem to be very small, while for a middle-income person (say full-time worker at your employer with working spouse), the extra taxes paid over many years could hurt them more because in retirement, SS will be a higher percentage of their income.

Actually, that gives me an idea of perhaps another way of doing a high-income cutoff: If annual SS benefits will be less than X% of annual retirement expenses, then use a Roth 401(k). I don't have a good number for X%, but it might be 10% or 15%. If 20% or higher, then probably a traditional 401(k) might be better. Just talking out loud here.
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Bill M
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Bill M »

physiorol wrote:
Bill M wrote:I don't know if it is advantageous to the plan to keep retired employees.... But if it is, a Roth option is definitely worthwhile. Otherwise us retired folk are forced to rollover the 401k money into an IRA before converting to Roth, and that means reducing the amount invested in the company-sponsored funds. If keeping retired account holders is a pure cost and not a benefit to the plan, then skip the Roth option.
Can you define retired employee? As owner I hope to work within this company for a long time. I may gradually cut back but do not anticipate not working in my field at all.
Perhaps "retired employee" is a bad term, since I'm obviously not both retired and an employee at the same time. As an employee at MegaCo, my 401k balance could be anything and the account would stay alive. But once I retired, if the account balance was less than $X (I think $20K, but not sure), the administrator/custodian would liquidate the account and send a check. Since my balance is higher, I'm allowed to keep the account as long as I want.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by grabiner »

Another question: Does your state have an income tax?

If your state has an income tax, that makes a Roth 401(k) less attractive; employees can deduct contributions to a traditional 401(k) from their state taxes, and if they retire to a state with no income tax (such as Florida), they won't pay state tax in retirement.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Clever_Username »

livesoft: thank you for the very detailed reply. I really appreciate it.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by livesoft »

GoldenFinch wrote:
livesoft wrote:Oh, I don't mind either way. Discussion is good.

So is it better to benefit 2% of employees and hurt 20% of employees? Or is it better to hurt 2% of employees and avoid hurting 20% of employees?
So (pleading genuine ignorance) how are any employees hurt? Are fees higher?
Some folks who choose a Roth 401(k) over a traditional 401(k) may end up paying $50,000 or $100,000 or even more in unnecessary income taxes.

Here is an extreme example similar to my situation: Suppose I am in the 28% marginal federal income tax bracket and pay some state income taxes at 5%, so 33% overall. I contribute the max to a 401(k) or $24,000 a year.

Two things should be immediately obvious:

1. My AGI will be $24,000 less if I use a traditional 401(k) than if I use a Roth 401(k).
2. 33% tax on $24,000 is $8,000.

Not so obvious:
3. Since I am in the 28% tax bracket, I will contribute the max to a Roth IRA regardless of my choice of 401(k).
4. If I contribute to a tradtional 401(k), I will put the $8,000 in taxes saved into a tax-efficient investment in a taxable account.
5. My reduced AGI could help with some tax preference items.
6. Maybe I am married and my spouse can also put $24,000 into a traditional 401(k).

So with a Roth 401(k) we could be paying an extra $16,000 in income taxes instead of investing that money in a taxable account every year.

Even less obvious:

7. Retire, live off of return of capital in the taxable account and capital gains (or even no capital gains do to tax-loss harvesting) while doing
8. Conversions of traditional 401(k) assets to Roth in a lower than 33% marginal income tax bracket.

Bottom line: It would take only a 8 years of paying $16,000 of avoidable taxes to cost one $100K that could have been avoided.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by whatusername? »

I lobbied my employer to add a Roth option to our 401k back when they first came out, and I think the marginal cost to the plan has been under $1000. I've used it ever since, and a few others have too (about 5-10% of our employees).

I'm a "highly compensated employee", but the Roth still works for me based on a long-term model I look at each year. The actual model itself is kind of involved, but the idea is that I determine how much I need each year in retirement to fund a specific after-tax amount (ie, what my taxes will be under different contribution scenarios so I know what my withdrawals will need to be; it's based on my scheduled savings each year and current tax rules). Based on my scheduled savings and allocations to my 401k, I come out substantially better making Roth contributions, as opposed to making traditional contributions with reinvested tax savings in traditional, in two directions: the more money I want/need to spend in retirement each year, and where my accounts return less than 3% real once I am retired.

(This model is imperfect as it assumes no increase in tax rates, ignores the sequence of returns, and assumes Roth treatment will not be altered. Close enough, though. Plus it doesn't contemplate not maxing contributions each year. Ymmv.)

Our 401k is through Fido, and they handle the administrative tasks on our plan. Since they also process our payroll, my employer has no ongoing burden on record keeping that they wouldn't have from just the traditional option.

If I worked for you, OP, I'd be in favor of the offering based on the value to me relative to the small marginal cost my employer incurred (I even offered to pay it personally at the time).

Edited to add: no state income tax helps make the choice easier.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by dharrythomas »

Check the statistics, if you're thinking about the employees--an insignificant number of people use the Roth option. The usage rates don't justify the paperwork for most small businesses.

Check your plan, I worked for a small business and while we had teenagers in the house and a house payment, I was saving 5% in the plan to get the match. Even at what is a savings rate that will get you laughed off this board, other than the owners, I was saving twice what anyone else was. :shock: I was shocked when I found that out, but have since discovered that was not unusual.

Read the book "Blink" about how people make decisions.

If you are building your plan to cater to a few outliers or to make people happy, add a Roth option and 6 dozen funds. If you are truly concerned about your average employees, limit the fund options, make Target Retirement and a deferral to capture the match as your going in default, and don't bother with the Roth.

With limited options, the employees are more likely to make a decision and they are more likely to choose a "not bad" option. And I say that as a person who has used the Roth option instead of traditional at every opportunity.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by bayview »

At current tax brackets, we will be in the 15% bracket in retirement.

But 80% of our income will be SS, and the rest will be a federal pension. We'd prefer to not have large-ish taxable RMDs make our SS income taxable.

Harry Sit's (tfb's) take on this: http://thefinancebuff.com/most-tsp-part ... h-tsp.html

There are a lot of us out there who never made all that much, and whose retirement account totals barely move the needle relative to others, but when SS is a big chunk of your retirement income, it's not good having it eaten away by taxes. I realize that our situation isn't common, but I don't think that one can make an across-the-board determination that Roth 401(k)'s are not useful.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Caduceus »

I think the fear that people might mistakenly choose a Roth 401(k) is probably overblown. There isn't a great deal of data in this thread, but EBRI has a good bit of information on how popular Roth 401ks are, who is most likely to take advantage of them, and what the median and average account balances are. (They are not that popular, which explains why brokers have been slow to offer them to small business owners.)

I think a Roth 401(k) is extremely valuable to younger professionals in the 15% bracket, especially if they are aggressive savers. I know plenty of people like that, so it's really not that uncommon.

The problem with not providing the option in the company plan is that it automatically disadvantages an entire group of people (younger, lower earners, aggressive savers). In a theoretical world, there are people on the margins of the decision who probably do contribute to a Roth 401k when a traditional would be more efficient. But in the real world, I suspect many of the people who contribute to a traditional 401k simply do not invest the tax "savings" in a taxable account; it simply goes into more consumption instead.

In conversations with colleagues, people often do not tax adjust their contributions mentally. They will contribute $5000 to their Roth 401k or their traditional 401k. So who is to say that the additional dollars in the Roth, while not the most efficient path, did not result in greater savings?

Livesoft's point is something that Richard Thaler made when he analyzed retirement systems - people become paralyzed when faced with more choices and they end up making worse decisions. But I think this idea cuts both ways. Nudging people to save more dollars that would otherwise have been spent may not be the worst thing.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by bayview »

Just from what I hear around the water cooler:

Most folks are going to do whatever decreases their tax bites/ increases their take-home pay.

I don't think that a lot of people will mistakenly sign up for Roth 401(k)s. In the end, their questions to HR/payroll are going to generally be along the lines of "So what will go into my bank account every two weeks?" --and that means a traditional 401(k). And that will be their decision-making process.

Back to OP: honors to you for trying to figure out what's best for your employees! :beer
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by SGM »

One of my children has a 401K plan without the Roth option. His tax bracket will be a lot higher in the future and during retirement. His Roth IRA is maximized every year, but he is missing out on tax free compounding in his 401K for the next 30 or more years. An employer has no idea what the future tax situation will be for an individual employee. Many employees have no idea how high their tax brackets will be in retirement.

One of our 401K equivalents grew at an effective rate of 10% per year for 30 years. It would have been nice if Roth 401Ks were available back then.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by bayview »

SGM wrote:One of my children has a 401K plan without the Roth option. His tax bracket will be a lot higher in the future and during retirement. His Roth IRA is maximized every year, but he is missing out on tax free compounding in his 401K for the next 30 or more years. An employer has no idea what the future tax situation will be for an individual employee. Many employees have no idea how high their tax brackets will be in retirement.

One of our 401K equivalents grew at an effective rate of 10% per year for 30 years. It would have been nice if Roth 401Ks were available back then.
I wish that I had known of (thought of!) the BH advice to put enough in the standard 401(k) to get the employer match, then max out a Roth IRA, and then (if appropriate) go back to the 401(k.) Taxes are ouchy, but we would be in a much better state approaching retirement had I done this.

Now in my geriatric years :D, a Roth TSP with the much higher allowed amounts is my best chance at playing catch-up ball. Yes, I realize that there will be RMDs pulling down my beloved G fund (well, at least beloved for now), but at least we won't have taxable income raising havoc with our SS income.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by master36 »

I recently started splitting my contributions 50/50 to traditional 401K and Roth 401K. I am currently in a high tax bracket, but as some of the posters suggested tax rates will be unknown in the future. I'm in the school of thought that rates will go up, which is the main reason I am doing this today.

In addition to this, there are a few other reasons why I chose this:

1. There are no RMDs on Roths
2. If my income happens to be lower in retirement - I can leverage the Roth for "lump sum" expenses. For example, I may have unforeseen medical expense, I may have a wedding to foot the bill for, I may choose to buy a summer home. If i choose to pull from my Roth, increasing my taxable income for the year, that income will be tax free.

Always interested in other opinons on this! Let me know if I am missing anything.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by bayview »

master36 wrote:I recently started splitting my contributions 50/50 to traditional 401K and Roth 401K. I am currently in a high tax bracket, but as some of the posters suggested tax rates will be unknown in the future. I'm in the school of thought that rates will go up, which is the main reason I am doing this today.

In addition to this, there are a few other reasons why I chose this:

1. There are no RMDs on Roths
2. If my income happens to be lower in retirement - I can leverage the Roth for "lump sum" expenses. For example, I may have unforeseen medical expense, I may have a wedding to foot the bill for, I may choose to buy a summer home. If i choose to pull from my Roth, increasing my taxable income for the year, that income will be tax free.

Always interested in other opinons on this! Let me know if I am missing anything.
Please check your plan. In many (most? all?) cases, there are RMD's on Roth 401(k)s. The difference, of course, is that the RMD's on Roth 410(k)s are not taxable.

If you want to avoid RMD's, you would want to roll your Roth 401(k)s over to Roth IRAs when you retire. At the moment, these do not have RMDs.

Ain't nothin' simple in this world we live in. :D
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by master36 »

Appreciate the fact checking - I will make sure to convert to a Roth IRA!

Any thoughts on the second point?
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by DSInvestor »

master36 wrote: 2. If my income happens to be lower in retirement - I can leverage the Roth for "lump sum" expenses. For example, I may have unforeseen medical expense, I may have a wedding to foot the bill for, I may choose to buy a summer home. If i choose to pull from my Roth, increasing my taxable income for the year, that income will be tax free.
If you contribute to Roth 401k rather than Traditional 401k, you'd have less money in your paychecks that you can use to:
1. Save and pay for next car, medical expenses, weddings, summer home, student loans etc.
2. Invest in taxable accounts.

Remember that the tax break that you give up for Roth 401k contributions is at your highest marginal rates. Traditional 401k contributions reduce your income at the top of income stack while you're earning so the tax break is at your marginal rates. Your withdrawals from traditional accounts fills your income stack from the bottom and slowly creep up the tax brackets. The 0% bracket provided by deductions and exemptions adjusts for inflation every year. If you do not have a defined benefit pension or can delay social security, your traditional withdrawals will first fall in 0%, then in other lower tx brackets. The average rate paid on the withdrawals may be lower than the marginal rates got at the time of contribution. If you will have a generous pension that will consume all of your 0% bracket and other lower brackets, that will push your Traditional withdrawals to fall in higher brackets and thus be taxed at higher rates. The composition of your income in retirement is important.

If there is no generous defined benefit pension in the picture and one is in 25% bracket or higher, I think a good plan would be to max out Traditional 401k, Roth IRA (via backdoor if necessary) and invest in taxable. This gives you a big 18K tax break, 5.5K Roth IRA space (another 5.5K for spouse if MFJ), and unlimited room in taxable. If one is high income and covered by employer plan, one does not give up a tax break to contribute to Roth IRA. You'd have lots of tax diversification.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by JamesSFO »

I respect livesoft tremendously, and he is one of the people who convinced me personally to switch from Roth --> traditional contributions.

That said, I believe plans should have a Roth option. Different workers have different plans and different beliefs about future government policies, tax rates, etc. I would rather focus on good defaults, good low cost funds, and if the worst mistake an emp makes is picking the Roth 401K over the Trad, so be it.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by DSInvestor »

One of the features of Roth 401k that I do not like is that the Roth 401k contributions are irrevocable once made. You cannot change your mind later like you can with Roth IRA (recharacterization). With Traditional 401k contributions there are options. That money sits in the traditional account and you get a tax break. If you decide later that you don't want the tax break, there may be opportunities to convert to Roth:
1) If the plan is a Roth 401k with in-plan conversion feature, convert in-plan.
2) job change - rollover to IRA. Once in IRA, convert any amount to Roth IRA.

Another thing I don't like is that you give up a tax break to contribute Roth 401k. The same may not be true of Roth IRA for those who cannot deduct Traditional IRA contributions to due to coverage by employer plan and have MAGI above certain limits.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Caduceus »

Actually, given the statistics on what is a median gross income, more people than not have a taxable income that puts them squarely in the 15% bracket or lower. So there is every reason for employers to offer a Roth option.

Not having a Roth option disadvantages precisely those people (the low-earners) who need the tax-free growth the most.

Because we are on this forum, we assume that a baseline case is for people to mistakenly choose the Roth when they should choose the traditional. But I wonder how many people save in the traditional (thinking it will save them lots on taxes) when they would actually be better off in the Roth.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by dodecahedron »

Caduceus wrote:Actually, given the statistics on what is a median gross income, more people than not have a taxable income that puts them squarely in the 15% bracket or lower. So there is every reason for employers to offer a Roth option.

Not having a Roth option disadvantages precisely those people (the low-earners) who need the tax-free growth the most.

Because we are on this forum, we assume that a baseline case is for people to mistakenly choose the Roth when they should choose the traditional. But I wonder how many people save in the traditional (thinking it will save them lots on taxes) when they would actually be better off in the Roth.
Excellent point. A number of folks who use Volunteer Income Tax Assistance (VITA) programs are actually in a situation where they face a negative income tax rate with respect to their AGI due to refundable EITC credit. A traditional 401k contribution would be counterproductive, but a Roth would make a great deal of sense for them (because they would also qualify for a savers' credit that could further reduce their cost of saving.)
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by steve roy »

I've been involved with a multi-player 401(k) Plan for twenty years. We're adding a Roth option the end of the year, due to participant demand. Personally, I don't think it's a swift idea for employees in their peak earning years to do a Roth 401(k), because the tax break is more valuable NOW and (very likely) less valuable years later when these folks are in retirement.

Why pay bigger taxes when you don't have to? But that's what some people want to do.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by livesoft »

Caduceus wrote:Actually, given the statistics on what is a median gross income, more people than not have a taxable income that puts them squarely in the 15% bracket or lower. So there is every reason for employers to offer a Roth option.
How so? Those folks will probably be in the 0% tax bracket in retirement. So why pay even 15% tax going in when they can pay 0% going in and 0% coming out? I did hear that 47% of folks don't pay income taxes. Same story: 0% going in and 0% coming out with a traditional 401(k).
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by dodecahedron »

steve roy wrote: Personally, I don't think it's a swift idea for employees in their peak earning years to do a Roth 401(k), because the tax break is more valuable NOW and (very likely) less valuable years later when these folks are in retirement.
Agreed--given your proviso in red
Why pay bigger taxes when you don't have to? But that's what some people want to do.
But, at any given point in time, most folks are not in their "peak earning years" (or at least their household incomes may not be at their peak, even if their own personal income is peaking, e.g., due to a spouse with a disability or caring for children, losses in a side business, etc.) That is why it seems reasonable to me to offer both alternatives.

Another factor not yet discussed: if there is insufficient participation in the plan by lower paid employees in a organization, the 401k plan may fail to meet certain IRS qualification tests, so that is another factor arguing in favor of adding options that will make the plan more attractive to low paid employees.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by dodecahedron »

livesoft wrote:
Caduceus wrote:Actually, given the statistics on what is a median gross income, more people than not have a taxable income that puts them squarely in the 15% bracket or lower. So there is every reason for employers to offer a Roth option.
How so? Those folks will probably be in the 0% tax bracket in retirement. So why pay even 15% tax going in when they can pay 0% going in and 0% coming out? I did hear that 47% of folks don't pay income taxes. Same story: 0% going in and 0% coming out with a traditional 401(k).
Lots of the people who are below the median gross income at a given point in time are only there temporarily (e.g., students balancing part-time low paid work with their studies, folks who only work part of the year due to entering or leaving the job force in the middle of the year or a disability, etc.)

So they may be in the 47% now (and may be paying not 15% but 0 or negative marginal taxes on their Roth 401k contributions going in) but may be facing positive marginal tax rates on distributions in retirement.

Through the VITA program, I am very aware of the tax profiles of folks at all different phases of life. The same income earned by a single head of household with a couple of children may face a negative marginal tax rate at point X in her life. At an earlier or later point in her life (perhaps she has lost or gained custody of the kids to/from the other spouse or they have grown up and she's no longer eligible for EITC or she has gotten married to a higher income spouse etc.) she may be facing a much higher marginal tax rate even though her personal salary may not have changed much. So for many taxpayers, there can be years when a Roth dominates and years when a traditional dominates.

Someone who works as a custodian at a state university or the county nursing home or the jail supporting a couple kids may face negative tax rates when the kids are little. After retirement, the combination of a state pension and Social Security plus RMDs could face positive marginal rates.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by livesoft »

Ah, you have brought back some memories for me …. I worked as a custodian at the university for several years. I also worked as a nurse's aide making minimum wage.

Low wage folks will not be generally maxing out retirement plan contributions. They don't have the money. They will be eligible for an individual Roth IRA or individual traditional IRA and will not be able to max out those contributions as well. They will only need to contribute to a 401(k) for a company match and the company match will go into the traditional 401(k) portion.

Enlightened employers who want to increase participation rates and help employees will contribute to employees 401(k)s even if they do not contribute. My former employer did this. All employees were enjoyed and got a corporate contribution whether the employee contributed to the 401(k) or not. In such a situation, while a Roth 401(k) would have been nice, I do not think it is necessary for low-wage employees because they could open Roth IRAs if they wanted to. They would not get confused possibly by the 2 kinds of 401(k) accounts they would have.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by dodecahedron »

livesoft wrote:Ah, you have brought back some memories for me …. I worked as a custodian at the university for several years. I also worked as a nurse's aide making minimum wage.

Low wage folks will not be generally maxing out retirement plan contributions. They don't have the money. They will be eligible for an individual Roth IRA or individual traditional IRA and will not be able to max out those contributions as well. They will only need to contribute to a 401(k) for a company match and the company match will go into the traditional 401(k) portion.
Agreed they won't be maxing out their contributions. Generally, the only contributions they make will be to their employer plans (in order to get the match, which is a better deal for them than the IRA, since they don't get a match on the IRA.) The employer match, of course, will go to the traditional (by IRS rules) but their own contribution may be a better deal for them if they do it as a Roth 401k contribution. Between the savers credit and the employer match, the effective out of pocket cost of their Roth contribution may be quite low. If they are in refundable EITC territory on the phase-in portion, the Roth contribution can be an even better deal (upfront) than the traditional (without even considering back end differences.)
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Ybsybs »

Some low earning people live with family and have very low costs. Low income does not mean low savings rate. It also doesn't mean low income for life. Examples: interns, college kids working summers.

People with pensions also often can benefit from a Roth 401k equivalent. And while pensions are very rare in corporate America, they are still very much part of the military service benefits package. Enlist at 18 or get a commission at 22 and if you stay in there's a retirement pension that starts paying out as soon as 38 or 42 & is inflation adjusted & continues for the rest of your life even while you have a second/third/fourth career. Or maybe you leave active duty but affiliate with the reserves. Your pension then starts at 60.

There are people for whom a Roth 401k or Roth TSP is a great option.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Caduceus »

livesoft wrote: How so? Those folks will probably be in the 0% tax bracket in retirement. So why pay even 15% tax going in when they can pay 0% going in and 0% coming out? I did hear that 47% of folks don't pay income taxes. Same story: 0% going in and 0% coming out with a traditional 401(k).
Maybe we just live around different classes of people. I know plenty of people who don't make much (usually temporarily so) and who do contribute substantial amounts to a 401(k). The situations are quite varied, but at least three of them contribute a five figure sum to their 401(k) and pay no income tax.

If there is 0% going in and 0% going out, the Roth is superior because it provides a hedge against a potential increase in future lifetime income as well as a change in the tax rate. This seems fairly obvious. The 0% tax bracket on income going in is known. The 0% tax on income going out on retirement is only, as you put it, "probable."

I don't disagree that a traditional 401(k) makes more sense for most people who can save a lot, but I don't see a need to be dogmatic about this position. OP, maybe you should survey your employees and ask them. And check if a Roth 401(k) really adds that much administration on your end. It was not the case for me.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by livesoft »

Caduceus wrote:If there is 0% going in and 0% going out, the Roth is superior ....
That's absolutely true, but it may be that making deductible traditional IRA or traditional 401(k) contributions is what puts one in the 0% tax range.

In any event, I have already agreed that a Roth 401(k) is better than a traditional 401(k) for some people. And I think everybody also agrees that a traditional 401(k) is better than a Roth 401(k) for some people.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by dmcmahon »

As an employee, the Roth 401k is of little benefit to me at the moment due to my tax situation. However, it's existence means that in retirement I'll be able to convert funds into a Roth without first moving them to an IRA, which is a plus. So the employees who'll benefit may be a larger group than you think.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by leonard »

I work with employees on a 401k that has both traditional and Roth options.

Surprisingly, the Roth option doesn't create much if any confusion.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Scott6647 »

I was speaking with a friend the other day and he brought up another great point about his Roth 401k contributions. He recently left a job and was able to roll over his Roth 401k into a Roth IRA. It was obviously a much higher sum than if he had just contributed to a Roth IRA because of the increased allowable contributions.

In 5 years he is going to drop his disability insurance and self insure with his rolled over Roth 401k. He can withdraw his significant contributions tax free at that time. In the case of disability there is a high chance you can wind up with a large lump sum needed. His savings by self insuring can be invested as well.

If his option was to only use the traditional 401k for a large lump sum his tax burden and 10 percent penalty would be huge in that scenario.

Given the rate at which young people switch jobs this is an attractive option.

To get back to the OP questions I would argue it is a no brainer to offer a Roth option. Live soft may be correct and some people may overpay taxes but if it gives some employee an opportunity to sleep well at night it is a worthy addition.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by Dulocracy »

livesoft wrote:
Dulocracy wrote: Whether or not it is the best option for them is for the employees to decide. The fact that it is a huge morale boost is more relevant for a company to consider.
Do you think there is any liability for letting folks choose a poorer tax option for themselves because they go for the morale boost rather than the cold hard numbers on taxes?
To the contrary! I think that I should NOT force people into a poorer tax option. That is why the firm makes BOTH options available. It is not for me to determine that one or the other is good or bad for them. I actually suspect that Roth is better for several, but I have not discussed it with them (and will not be doing so). (We also pay an adviser that they are free to use to determine which option to go with, but they are not required to use him. We stay out of that entirely.)
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by dodecahedron »

I had very large deductions last year. After taking into account my deductions and credits, I face a zero marginal tax rate. I am very glad my employer offers a Roth 403b plan. (I.e., I am glad there are no folks like livesoft on our retirement plan committee.)

Essentially my entire part-time gross earned income went into my Roth 403b (invested in TIAA-CREF Trad SRA paying 3%, fully liquid). Plus, I am also contributing the max 6500 to a Roth IRA (invested in Vanguard bond funds). (There's a weird anomaly if you contribute to a Roth employer plan. You can effectively contribute 6500 of the same earned income twice. This does not work if you contribute to a traditional employer plan.)

The only other wish I have is that my employer allowed in-plan conversions from traditional to Roth. Actually my employer would like to offer employees the option to do in-plan Roth conversions but TIAA-CREF says its platform is not yet set up to allow them. They are "working on it."

Apparently a growing number of 401k plans allow this type of in-plan conversion. There are many for whom it makes sense, e.g., employees whose income is temporarily low as they phase into retirement or take FMLA leave or their spouse stops working to return to school, etc.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by itstoomuch »

In the last years of Wife's working life, her company had 401k-Roth. We had an effective tax rate of $0, living very frugal, taking care of two invalid parents. Pretax 401k was a waste on us. We used as much of Roth401k and RothIRA as possible. I made some good investment decisions concerning our retirements, and a recent inheritance, we will jump from a $0 effective to 25% marginal/85% tax on SS. The Roth's has enabled me to better tax manage and investment manage our retirement portfolios. :wink:
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by livesoft »

@dodecahedron, in 2015 I started a solo 401(k) now with both a traditional 401(k) and a Roth 401(k) account. I contributed my full compensation to my traditional 401(k) even though I am in a ridiculously low tax bracket. It would not hurt me to contribute to the traditional 401(k) even if I was in the 0% marginal income tax bracket. Why is it? The reason is that I converted old traditional IRAs into Roth IRAs up to the limit of the 15% marginal income tax bracket, so the amount of money going into Roth accounts was up to the limit of my tax bracket.

It is true that you have a special situation that does not apply to me. I was still able to contribute $6500 to my Roth IRA even though all my compensation went into my traditional 401(k). And you were able to contribute some of the same money to two different Roths. Nicely done! But what about Roth conversions for you?
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by jwillis77373 »

livesoft wrote:... Workers should capture company match first by contributing to company 401(k). They can do this in traditional and use the tax savings to contribute to a Roth IRA. ...
That is a totally awesome idea.

I really like it when people focus on absolutes and what "they can do" as opposed to pure guesswork. Gaining the benefits of a reduced AGI is in the "immediate" tax year.. [and] it lowers their taxable gain burden in their taxable accounts should they choose or have to sell.. they could even use that to [also] fund their Roth IRA.. so its kind of "double dipping".. they get a reduced AGI [and] lower capital gains (this year.. not some year way down the road)(not to mention a non-taxable growth on earnings way down the road) all because they saved in a before-tax 401k as opposed to a Roth 401k.
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Re: Pros and cons of adding Roth Option to 401K Plan

Post by dodecahedron »

livesoft wrote: It is true that you have a special situation that does not apply to me. I was still able to contribute $6500 to my Roth IRA even though all my compensation went into my traditional 401(k). And you were able to contribute some of the same money to two different Roths. Nicely done! But what about Roth conversions for you?
Unfortunately, Roth conversions don't work for me right now.

I had previously rolled *all* my traditional retirement funds into my current employer's traditional 403b in order to get them into TIAA-CREF Trad SRA paying 3%. The only Roth conversion I am interested in doing would be to do an in-plan conversion of funds currently in the traditional 403b to the Roth 403b TIAA-CREF SRA paying 3%. This is legally possible, but TIAA-CREF has not yet built the platform to enable it. I was wrongly told in August of last year that it would be possible and indeed TIAA-CREF was planning to finish the software changes to enable the in-plan conversion to be possible by Nov 2015, but the project ran overtime and it was ultimately not possible to do the in-plan conversion in 2015.

I did have the option to do an inservice withdrawal to move the funds into a Roth IRA, but I vastly prefer to convert into the Roth 403b, which allows me to keep the money in safe liquid fixed income paying 3%, something I can't get in an IRA.

I am hoping that TIAA-CREF finishes doing whatever they need to do so I can do in-plan Roth conversions starting in 2016.

The bottom line is that conversions and/or contributions to a Roth IRA are NOT perfect substitutes for conversions and/or contributions to a Roth employer plan, because the employer plan may have investment options (e.g., stable value funds, TSP G fund, etc.) that are not available in an IRA.
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