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All Else Being Equal…

I don’t know how it is where you live, but in the Beltway it seems that all anybody can talk about is Roth.

More precisely, the talk is about “Rothification,” specifically the elimination of some — or in certain ‘worst case’ scenarios, all — of the employee pre-tax savings advantages of the 401(k).

You hear a number of specific concerns expressed: that workers now forced to pay taxes upfront will reduce their retirement savings rather than their take-home pay, or that workers, having been sold since the birth of the 401(k) on the benefits of pre-tax contributions, will, in a fit of pique, simply quit saving altogether, and even that employers – particularly small employers — deprived of the personal tax preferences — will cease sponsoring (or refuse to offer in the first place) workplace retirement plans.

There are indeed surveys that suggest that American workers like the tax preferences that currently serve to reward, if not encourage their retirement savings — while huge majorities in those same polls express outrage at the prospect that those preferences would be removed.

Make no mistake — “Rothification” would be a considerable shift in messaging for a plan design that draws its name from the provision in the Internal Revenue Code that permitted worker deferrals that met certain conditions to be set aside before giving Uncle Sam his “cut.”

That said, most of the concerns articulated about Rothification revolve around how workers save — and how those who sponsor the plans those workers save in might react.

Unfortunately, and as been noted here previously, there’s really no research dealing with the topic of how workers and employers might react that is directly on point. Indeed, the surveys that ask individuals about tax preferences — to the extent they are specific at all — nearly always focus on one particular aspect of those preferences — deferring taxes on contributions. The Roth advantages of not paying taxes on the accumulated earnings (though you’d owe taxes on those in your 401(k) withdrawals), and the freedom from being forced to take RMDs aren’t, to my reading, juxtaposed against the pre-tax contribution benefit. Nor do most discussions about post-retirement drawdowns acknowledge that some large chunk of those retirement savings will be due Uncle Sam. Of course, traditional communications about the benefits of pre-tax savings have assumed that savers would be in a lower tax bracket in retirement. But then, that’s not necessarily true, is it?

The title of a recent Wall Street Journal article offered a tantalizing conclusion: Roth vs. Traditional 401(k): Study Finds a Clear Winner. While the article referenced a new study, the comments in the article (and the link) harkened back to a 2015 study by John Beshears, James J. Choi, David Laibson and Brigitte C. Madrian that focused on 11 companies that added a Roth contribution option to their existing 401(k) plan between 2006 and 2010. That study found no decrease in employee contributions as a consequence of adding a Roth feature. However, it’s one thing to see no change in voluntary contributions when a new choice is added — yet another to conclude that that means there would be no reaction to having a popular and long-standing choice taken away.

As it turns out, the “clear” winner identified in the title, and in the researcher’s estimation, was the Roth — because every single dollar in the account can be withdrawn tax-free. But that conclusion is only valid if the workers saved the same amount in the Roth that they did in the 401(k) option.

In essence, all else being equal, Roth comes out ahead. The key is whether “all else” — in this case particularly the rate of savings — remains equal.

On that, only time — and perhaps some much-needed research — will tell.

Earlier this year, the Employee Benefit Research Institute (EBRI) indicated it would be fielding research relevant to the topic. Those results are expected shortly.