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Roth 401(k)s Are Slow to Gain Toehold Among Employee Portfolios

A new survey from the Profit Sharing/401k Council of America shows that more employers are offering Roth 401(k) plans, but many employees aren't taking advantage of this tax strategy.

October 26, 2011

Dental Associates chief financial officer Paul Seubert had been hearing for years that employees wanted the option of making certain after-tax contributions—also known as Roth contributions—to their 401(k) plans.

So in January 2011, the Wauwatosa, Wisconsin-based consortium of multispecialty dental-treatment centers added the feature as an option to its traditional 401(k) plan.

"To some degree, I think it's important to offer what employees want," Seubert says. "There was no added cost and little effort on our part, so it seemed like a no-brainer."

Dental Assistants is part of a larger trend of employers offering Roth 401(k) accounts to participants. The Profit Sharing/401k Council of America's 54th Annual Survey of Profit Sharing and 401(k) Plans showed that of the 820 plans surveyed, 45.5 percent of employers allowed Roth 401(k) contributions in 2010. That's up from 41.3 percent in 2009, and 18.4 percent in 2006.

"You want a plan that is as broadly attractive as possible," says David Wray, president of the Profit Sharing/401k Council in Chicago. "There are individual workers who would like to diversify their tax situation, so companies are responding."

The Roth 401(k) is similar to a Roth individual retirement account, or IRA, in which participants pay a tax (based on their income bracket) on dollars going into the account. Just like in a traditional 401(k), the assets grow tax-free. But Roth distributions for eligible participants, usually 59½ and older, are not taxed.

The general advantage for many Roth 401(k) participants is paying taxes at the beginning of their working career when they are in a lower tax bracket as opposed to paying taxes at the end of their working years, when it's quite possible they will be making more money and would pay more taxes on distributions.

The Roth 401(k) has been around since 2001, but didn't see a lot of use until the Pension Protection Act of 2006 made permanent certain Roth rules that had been expected to sunset in 2010. Plus, the Small Business Jobs Act of 2010 made it possible for participants eligible for a distribution to convert traditional 401(k) assets directly into an employer-sponsored Roth plan, as opposed to rolling it out of the plan and into a Roth IRA.

Another gateway that is increasing use has been technology, observers say. It took some time for record keepers to update systems to handle the Roth 401(k), says Rick Meigs, president of the 401khelpcenter.com in Portland, Oregon.

Since the Pension Protection Act was enacted, the number of employers offering a Roth 401(k) has grown at least 2 to 3 percentage points annually, says Beth McHugh, vice president of market insights at Fidelity Investments in Boston. At the end of the third quarter this year, 31 percent of Fidelity's plans offered a Roth 401(k) option, compared with 20 percent in the third quarter of 2009.

"Plan sponsors are starting to look at providing participants with not just investment diversity, but tax diversity as well, and Roth is one way to do that," McHugh says.

Even though technology has made a Roth (401)k an easier option for employers to offer, employees are slow to invest. The Profit Sharing/401(k) Council's survey shows that 16.1 percent of employees use a Roth 401(k) when it's offered. Although the number is up 3 percentage points from the figures in last year's survey, observers agree that growth is slower than expected.

In the case of Dental Associates, only six of the company's 464 participants have Roth 401(k) accounts.

Nonetheless, "There are many companies out there who still feel [that] adding this feature and making it attractive, if only for a few, is still the right decision," Wray says.

Uncertainty and lack of education are why participants choose the traditional 401(k) route, several industry experts say. After all, going with a Roth 401(k) is making a prediction, the 401khelpcenter.com's Meigs says.

"It's a long-term bet that you're going to be at the same or higher tax rate" when you retire, he says. "We're all short-term-oriented, and the fact that you are taking a gamble that far out in the future is hard for a lot of people."

Wray says that, regarding education, many employees receive Roth information electronically, through information sessions or on paper. Investment advisers usually focus more on investment strategy and not the pros and cons of tax consequences, he says.

Dental Associates employees learned about their new option through quarterly staff meetings and an announcement by Fidelity, the company's plan trustee. Participants can go to Fidelity branches to get individual advice or take advantage of models online, but CFO Seubert wasn't sure whether participants were using these options.

"People know it's available, but we're not pushing it," he says.

Companies should make the Roth option a larger part of investment education, Meigs says.

"Every participant should investigate it, and plan sponsors should be doing more education," he says. "It could be a great tool, but [in terms of use] it seems to be languishing."