The 401(k), the stalwart of retirement accounts, has a younger sibling that’s starting to become more common in benefits menus in Rhode Island.
For many years, the Roth 401(k) has been included in the benefit packages offered by large companies, but more small companies are getting in on the act, making it available as an option for employees, according to retirement specialists and financial advisers.
The Roth version of the employer-sponsored plan offers many of the same tax benefits as the Roth individual retirement account, but it doesn’t have the same income limitations or contribution caps, said Manny Rezendes, an investment adviser representative for Euclid Financial Services LLC in East Providence.
The Roth IRA became an option for investors in 1997. The Roth 401(k) followed about 10 years later, and it still represents a small portion of investment accounts for retirement, according to recent surveys, Rezendes said, but it has some tax benefits over the traditional 401(k).
Like the Roth IRA, the money that is deposited in a Roth 401(k) has already had income taxes taken out. So this money then can grow and be withdrawn without another tax hit.
That’s a benefit if the account holder expects to be in a higher tax bracket when they retire, Rezendes said. It also is beneficial if the account holder’s tax rates rise over time, which could happen, he said.
‘As the money grows, you don’t have to pay the taxes on the growth.’
MANNY REZENDES, Euclid Financial Services
“The myth that when you retire you’re going to go into a lower tax bracket isn’t necessarily true anymore,” he said.
Two years ago, President Donald Trump’s administration moved to reduce the number of income brackets on federal income tax.
“People are realizing we are probably in the lowest personal income tax bracket in U.S. history,” Rezendes said. “In the 1980s, we had 17 different tax brackets and if you sneezed wrong, you went into a new tax bracket.”
While his experience has shown larger employers are more likely to offer the Roth 401(k), national surveys have shown that more small and midsized businesses have started to include it in their benefits package.
The most frequent avenue for this is when a company changes its 401(k) provider.
Like the traditional 401(k), automation makes it easier for employees.
“It’s systematic, so you don’t even have to think about it,” Rezendes said. “And it comes out before you ever see it in your paycheck. The positives are once you go into retirement, and you go to draw down on this money, you’ve already paid the taxes on it. So, as the money grows, you don’t have to pay the taxes on the growth either.”
For smaller employers, the expense of adding the benefit as a new option may be an issue. Any addition will carry an administrative fee, and some employers cover this while others pass it on to employees.
Employers who make matching contributions can apply them to the Roth 401(k) as well as the traditional, but the employer contributions are going to be made pre-tax to the accounts, Rezendes said.
Rhode Island’s smaller businesses are trying to offer a fuller menu of benefits, particularly as a recruiting tool. This can be complicated by the expense of offering a benefit, so it becomes a decision that’s shaped by the employees and what they want, said Cynthia Butler, president and founder of Butler & Associates Human Resources Consulting, of Jamestown.
Some younger workers still have to be persuaded to invest in retirement vehicles offered by employers. They can be preoccupied with repaying student loan debt and other financial issues.
Nationally, surveys point to a distressing percentage of Americans who haven’t saved for retirement at all. Rezendes said a recent survey found two-thirds of Americans aren’t saving in IRAs or 401(k)s. Of those who are, only 4% are choosing the Roth 401(k).
Ralph Coppola, senior adviser and vice president for corporate benefits at Ivy Wealth Management Inc. in Warwick, said of the plans offered by companies nationally, 75% offer the Roth 401(k), and that’s spread among small to large companies. “It’s pretty much across the board, at this point,” he said. “The larger ones have a larger percentage than the smaller ones.”
The Roth option generally works better the longer an investment is allowed to grow because of compounding dollars. The rule of 72 applies, he said, in that if an investment has a return of 7.2%, it will double every 10 years. “If you have that compounding working for you and you start off in your 20s, you will be paying tax on a small amount of dollars that will turn into a large amount of nontaxable dollars over time,” Coppola said.
The other advantage, he said, is that if you retire, money can be withdrawn from a Roth for a large purchase, such as a new roof on a house, and it will not push the account holder into a new tax bracket because it is not taxable income.
And, unlike a traditional IRA, the retiree doesn’t have to take required minimum distributions at age 70½. And it passes on to heirs without tax liability.
Mary MacDonald is a PBN staff writer. Contact her at Macdonald@PBN.com.
