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Don’t Overlook Your Roth 401K

written by Kay Pfleghardt

On January 1, 2006, employers were given the opportunity to offer their employees the new Roth 401(k) option1. Yet, as of January 1, 2017, only 49% of employers have chosen to implement this feature2.This month we take a look at why the Roth 401(k) is overlooked by so many plan sponsors, and what you can do to “Turbocharge your 401k” to keep your top employees happy.

The Roth 401k Powerplay

Regardless of which end of the wealth spectrum you fall, we can all agree that Roth IRAs are a great opportunity. Unfortunately, high income earners are disqualified from contributing directly to a Roth IRA. In 2016, if you and your spouse made anything over $194,000 you fell into this group. As it turns out, those high income earners are some of your most valued employees. Here’s something big that you can do to help them. Unlike the Traditional Roth IRA, the Roth 401(k) has no income limit restrictions. Under current tax law, employees are eligible to contribute up to $18,000 per year in after-tax money to a Roth 401(k), as long as their employer offers this option.

Tax-free is great, but why does it matter for employees that may retire in the same tax bracket they started out in? THIS is where plan sponsors have the chance to really make a difference for their participants. Here are just a few examples of the benefits of the Roth 401(k) that plan sponsors and some employees overlook:

  1. The Ability to Control Tax Brackets
    Although Roth 401(k) accounts also come with Required Minimum Distribution (RMDs) stipulations, this money comes out tax-free. So, high income retirees can draw on their retirement accounts to support their lifestyles, while actually paying less in taxes. Here’s an example:

    Mary & John made $120,000 of household income before retiring. They were in the 25% tax bracket in 2015. In 2016, they retired and withdrew $75,000 from their Traditional 401(k) accounts, and $45,000 from their Roth 401(k) accounts. This effectively kept them in the 25% tax bracket, and saved them $4,500 in taxes.
  2. Avoidable Required Minimum Distributions
    We mentioned before that employees are obligated to take RMDs from their Roth 401(k). Even so, there’s a simple trick to avoid this. There is no rollover limit on Traditional or Roth 401(k) accounts3. That means that employees have the opportunity to roll over their Roth 401(k) account into a personal Roth IRA – which does not have the RMD stipulation attached to it. Voila! No Roth 401(k) RMD conditions*.Their heirs will thank them, and you.
  3. Their Heirs Will Thank Them, and You.
    Unlike Traditional 401(k) accounts that require beneficiaries to pay tax on distributions they receive, Roth 401(k) account savers can leave their heirs with tax-free income. This literally allows participants to “pre-pay” taxes for future generations.

Things to Consider

It’s important to know that, your plan document may allow for employer contributions into your employees’ Roth 401(k) accounts. However, company matches are made on a pre-tax basis, and will be taxable upon the employee’s withdrawal.

Why Not a Roth Option?

So really, why do only 49% of Plan Sponsors offer the Roth 401(k) option for their employees? We think it has to do with one of two things. Some plan sponsors have never had someone take the time to help them understand the true power behind this feature. Better yet, they didn’t realize it could be an option for all employees. Others might think it’s just ‘too scary’ to tackle the grueling task of updating their company’s retirement plan. If you resonate with either of these feelings, it’s time to take a second look at the financial advisor servicing your plan.

This information is for use with the general public and is designed for educational or infomational purposes only. It is not intended or should not be construed as investment advice and is not a recommendation for retrement savings. Lincoln Financial Advisors Corp. and its representatives do not provide legal or tax advice. You may want to consult a legal or tax advisor regarding any legal or tax information as it relates to your personal circumstances.

1 http://www.pensionrights.org/publications/fact-sheet/new-type-savings-plan-roth-401k
2 https://www.psca.org/55th-annual-survey-highlights
3 http://www.bankrate.com/finance/retirement/after-tax-401k-rollover-to-roth-ira-rules.aspx