Roth 401(k) Account for Your Plan?
Roth 401(k) accounts were added by the Economic Growth and Tax Reform Act of 2001 (EGTRA) and became effective at the beginning of 2006. Many employers have been slow to move forward with adding Roth accounts to their plans. Recent events offer new incentive for employers to consider adding Roth accounts to their 401(k) plans. Find out why we believe the Roth account may be an attractive option for your employees.
Roth 401(k) Obstacles
Employers have been reluctant to add Roth accounts for a variety of reasons. The first important reason is that the law change is so new. As a result many plan service providers are not prepared to handle all of the new requirements for administering Roth accounts. There has also been very little guidance published by the Internal Revenue Service on important issues such as how loans, distributions and contributions must be tracked. Employers view adopting new Roth accounts like a consumer would view buying a car the first year it is manufactured: “Let somebody else work the bugs out.”
Secondly, the EGTRA legislation that initially created the Roth 401(k) accounts was not permanent. The EGTRA bill provided an end date of 2008 for these accounts. This lack of permanency concern many employers as they are not willing to change their plan for a feature that may be eliminated in a short time. There also is no clear indication in EGTRA regarding what would happen to Roth accounts if the legislation was not made permanent.
Finally, employers are unsure how many of their employees would actually utilize a Roth contribution. Employers assumed that any new feature in the plan would add to the administration cost and many employers were reluctant to incur the additional cost if their employees did not elect the option.
Recent Events
Roth 401(k) accounts were made permanent by the Pension Protection Act of 2006. It now appears that the legislators is trying to create as many incentives as possible for participants to save money in their 401(k) accounts. It does not seem likely that the Roth account feature will be changed or eliminated any time in the near future, making employers more confident in the adding the feature to their plan.
The IRS also published final regulations on many Roth account administration issues at the end of April 2007. These final regulations provide specific guidance for employers on a number of operational issues that were previously undefined.
These final regulations clarify the calculation of the five year waiting period to qualify for the tax-free distribution of the account. The regulations also covered the determination of the taxable portion of a distribution from a Roth account if the participant has not met the five year waiting period and age requirement.
Other issues covered by the final regulations include how roll-over contributions and distributions must be handled, tax treatment of Roth contributions returned to participants because of failed ADP tests and how to administer loans made from Roth 401(k) accounts. This additional guidance will make it easier for employers to administer their Roth 401(k) accounts.
Why Roth 401(k) For Your Employees
We believe there are a number of compelling reasons for employers to consider adding a Roth 401(k) account feature to their plan; highly-compensated employee benefits, existing implementation of Roth accounts in employees’ personal portfolios and tax benefits.
Many highly-compensated executives may not have been able to make contributions to a Roth IRA due to their income level. IRS regulations provide that married taxpayers may not make a Roth IRA contribution if their Adjusted Gross Income exceeds $160,000. A Roth 410(k) feature may be the only option for highly-compensated employees to contribute to their retirement and receive the tax benefits of a Roth account.
A number of your rank and file employees may already have a Roth IRA as part of their personal portfolio. By adding a Roth 401(k) account option, all of the employee’s money saved for future retirement is subject to the same tax considerations. Whether or not it is advantageous to have all of your money in a Roth account or in a pre-tax account has been the subject of much controversy. Our view is that the company’s best approach would be to offer both options.
By offering the Roth 401(k) account your employees will have the opportunity to accumulate money in both a Roth account and a pre-tax account. Our view is that your employees may enjoy the flexibility of having balances in both the pre-tax and Roth accounts as they plan for retirement and the possible tax consequences of distributions during retirement. This added flexibility will encourage your employees to participate in the plan to the fullest extent possible.
Please feel free to contact Steve Johnson in our office for further information regarding the benefits of establishing a Roth 401(k) account for your employees.
Retirement Solution Advisors, LLC - 410 W Grand Ave. - Chicago, IL 60610
Phone: (312) 923 8700 ext. 232 - Fax: (312) 923 8701
E-mail: steve.johnson@rsadvisorsllc.com
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