Most DC Plan Participants Don’t Understand Roths, Survey Finds
Amid all of the recent talk about tax reform and the potential move toward Rothification, Cerulli Associates has come out with a new report showing that only one-third of DC plan participants can correctly identify the benefits of Roth contributions.
The results are part of a 2017 survey Cerulli conducted with approximately 1,000 DC plan participants who were asked to select the data that best described Roth contributions. Two-thirds of respondents had either no understanding or a mistaken understanding of Roth contributions.
In a report accompanying the findings, Cerulli urges financial services firms with retirement-related business units to closely monitor tax reform and the potential Rothification of the DC market because it has the potential to “reshape the current retirement savings paradigm.”
“Given the lack of understanding of Roth contributions, the behavioral challenges associated with taxable contributions, and, importantly, the loss of the immediate benefit or incentive (tax bill deduction), Rothification could cause some individuals to reduce or cease their contributions to an employer-sponsored retirement savings plan,” Cerulli warns.
When asked what motivates them to begin saving for retirement, tax benefits were cited by more than one out of five participants (22%). When asked to identify factors that would motivate them to increase their 401(k) plan contributions, a combined 90% of participants responded that tax savings are either “very motivating” or “somewhat motivating.” (The top two factors cited were employer matching contributions and salary increase/bonus.)
Cerulli notes that some plan sponsors are hesitant to add a Roth option to their benefits package “because it may further complicate an area that confuses many employees.” In addition, the report warns that, should policymakers succeed in Rothifying the DC market, recordkeepers and advisors/consultants will need to invest significant resources in educating plan participants to address this shift or run the risk of a drop in contributions.
As we noted here, an idea that is “quietly being discussed” in the context of tax reform is altering the current pre-tax treatment of 401(k) contributions. In fact, it always seems that retirement tax incentives come under threat in every major tax reform debate. As Cerulli points out, this is because of the large “tax expenditure” price tag associated with the provisions under the congressional budget rules. Using 2016 data, the report notes that estimated income tax expenditures for contributions to DC plans is $921 billion and to IRAs is $197 billion for a combined $1.1 trillion of total expenditures for fiscal years 2016-2025.
“If the new tax code moves these participants into a higher tax bracket, and, because of Rothification, causes them to lose the ability to reduce their tax bill through pre-tax contributions to a DC plan, some participants may feel pressure to reduce their deferrals,” the report contends.
To get out in front of tax reform, Cerulli urges stakeholders to emphasize that any move toward a Roth system should be done on a non-elective basis, such that the legislation is crafted in a way that participants are not required to confirm their current deferral rate for future Roth contributions. The report also encourages stakeholders to stress the importance of an employer match within the context of a Roth system, and frame the tax break as a salary raise and an opportunity to increase retirement plan deferrals.
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