Roth 401(k)s Are an Essential Employee Benefit

Employee retirement readiness is at the forefront of plan sponsor concerns. As a result, many plan sponsors are adding the option for Roth 401(k) contributions of their plan. Roth 401(k)s were first introduced in 2006, and while the adoption rate by employers was initially slow, it has since skyrocketed. As many as 70% of 401(k) plans now offer Roth 401(k) options, alongside the traditional 401(k). While the Roth 401(k) option is not for everyone, plan sponsors should consider providing this option to give employees additional retirement savings options. Having this feature as part of the employee benefits package will make your 401(k) plan more attractive and will allow your organization to remain competitive to attract and retain top talent. We have outlined important points to keep in mind if you’re considering adding a Roth 401(k) option to your plan.

What is a Roth 401(k)

The Roth 401(k) serves as a 401(k)-Roth IRA hybrid. Like the traditional 401(k), it can only be offered by employers, but like a Roth IRA, the contributions are after-tax dollars so participants will not face additional taxes on those savings or any investment earnings upon withdrawal during retirement, provided a couple of conditions are met as described below. A Roth 401(k) feature is not a completely separate retirement plan. It is a different type of contribution to an existing plan, and employees can contribute to both or just one of these options.

Roth 401(k) holders can start taking tax-free distributions, provided that the Roth account has been open for more than five years and the participant is 59 ½ years old, or on the account of death or disability. All of the profits generated within the account are 100 percent tax-free. As a result, participants benefit immensely when they make contributions over a long period and enjoy strong returns.

Roth 401(k) Rules and Important Points

• Roth 401(k) contribution limits are capped at $19,000. Those 50 years old or over can contribute up to $25,000.
• Not Exempt from Required Minimum Distributions (RMDs). Distributions must begin at 70 ½, unless still working. While Roth IRAs are exempt from the IRS RMD rules, the Roth 401(k) is not. Roth 401(k) owners can avoid this requirement if they roll their Roth 401(k) into a Roth IRA before turning 70 ½ years old.
• There is no income limitation to participate. Unlike the Roth IRA, the Roth 401(k) has no income limit. Many of your employees may not be eligible to contribute to a Roth IRA because their income is over the IRS imposed limit. Offering a Roth 401(k) provides them with a post-tax contribution option.
• Roth 401(k) contributions and earning must be tracked separately. While adding the Roth 401(k) option is not a large cost since it’s just an added feature, due to the plan administration involved, your recordkeeper may charge an additional fee for Roth accounts.
• Employer matches are taxed at withdrawal. Employers can choose to match contributions on a participant’s Roth 401(k). However, the employer contributions are kept in a separate account that will be taxed at withdrawal since they are made on a pre-tax basis.
• In-plan Roth rollovers. In-plan conversions from a traditional 401(k) account to a Roth 401(k) is permitted, though participants must pay tax on the converted dollars. However, it’s important to educate participants considering this transaction to proceed with caution because unlike the Roth IRA, they will not be able to return funds to their initial 401(k) plan.

Impact of Offering a Roth 401(k) Option

Offering a Roth 401(k) option increases your organization’s competitiveness in the employment market. Many high-income individuals and millennials looking forward to income growth want the Roth 401(k) option anticipating higher tax rates closer to retirement. Adding this option to your plan allows participants to save into two accounts with different tax benefits.

Plan sponsors should be aware that most participants won’t realize the benefits of Roth 401(k) on their own. Like any investment option, sponsors should educate participants about how the feature works, how it impacts their saving and planning, and how to decide between a Roth 401(k) and a traditional 401(k).

PlanPILOT can help optimize your employee benefits plan, so you can attract and retain the top talent that will make your organization thrive. Contact us today at (312) 973-4911 or email info@planpilot.com.

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