Counting on Roth

Some of the SECURE 2.0 Act of 2022’s most heralded provisions are also among its costliest.

Consider tax incentives starting in 2025 that will make starting a 401(k) plan free for the first three years. Or the Saver’s Match coming in 2027 that will provide a 50% federal matching contribution deposited directly into a taxpayer’s workplace or individual retirement plan.

As with much federal legislation, the costs of the programs are offset by other initiatives—in this case, in part by boosting Roth 401(k) contributions that will bring retirement saving tax revenue to the government immediately.

“Roth is paying for [the tax credits for new retirement plans within] SECURE 2.0,” says Kevin Gaston, director of plan design consulting for Vestwell. “Roth has been in 401(k)s, but it is now required for catch-up contributions [for high-income earners] and available in a host of other areas such as [pension-linked emergency savings accounts], or emergency savings, student loan matching and now employer contributions.”

These Roth provisions, Gaston posits, is partly why SECURE 2.0 passed so soundly across party lines in March ahead of implementation.

The plan design consultant, like many in the retirement space, sees advantages for participants in using Roth. Even so, there are many stumbling blocks to Roth uptake at the levels the government is likely counting on.

Beyond the mandatory Roth catch-up for high-income earners, many of the provisions are optional and will require plan sponsor and adviser belief and adoption. And that’s all before convincing participants to take the income tax hit up front rather than deferred, Gaston notes.

“That person making $75,000 may not value the benefit as much as a more tax-savvy person might,” he says. “I find it difficult to see the rank-and-file worker going for Roth immediately as a lot of other things would have to be going their way to decide on taking the tax hit.”

In the near-term, Gaston sees small plan sponsors with those higher-income earning pools—think doctors, lawyers and tech workers—taking advantage of Roth ahead of many larger companies. And even then, participant uptake will likely need education and smart plan design to really take off.

Growing Pains

Matthew Calloway, principal of the law and policy group at Mercer, notes that while there has been a good deal of regulatory guidance on Roth implementation since SECURE 2.0 came out, further guidance is needed.

When first announced the Roth catch-up provision had a lot of plan sponsors and advisers scrambling for implementation , so a two-year extension from the Internal Revenue Service was met with great relief. Even so, there are still lingering questions, Calloway says, including whether plans that do not allow Roth contributions can continue to offer catch-ups for employees who are not high earners.

“It’s still a little bit uncertain,” Calloway says.

He notes other further questions around the many Roth options for plan sponsors, such as whether participants can be defaulted into Roth savings or not. Such uncertainty could crimp uptake.

“The question becomes whether sponsors will have the incentives to adopt these features,” he notes.

Justin Morgan, director of fiduciary consulting and adviser solutions at American Trust Wealth, an AmericanTCS business, expects Roth in-plan savings to grow in light of the challenges—though it may be incremental.

“If you look at industry data, the number of participants making Roth contributions does grow year-to-year, but only by about 2% to 3%,” he says. “I think that’s mostly due to the participant side—obviously there is still an educational component to all of this.”

Participant Uptake

As with most qualified retirement plans, automatic deferrals and increases are the most effective, with optional benefits—even if being offered by most plan sponsors—seeing lower adoption rates. So, while Morgan sees “a lot of energy” behind Roth options, such as employer matching, as long as it’s an opt-in “it will take time for broader adoption and a more substantial shift.”

Those pushes, he says, will come from continued work in two key areas:

• The government will encourage and potentially mandate Roth contributions to help bring in tax revenue to pay for other benefits.
• Financial advisers advocating for Roth due to the tax implications and withdrawal benefits for many participants.

“Generally, it’s another arrow in the quiver for the participant in how they are managing their strategies, and more choices generally is a good thing,” he says. “Conversations with clients to date have been more at the employer/plan sponsor level and building a familiarity campaign.”

Barbara Van Zomeren, senior vice president of ERISA at Ascensus, notes the success of Roth IRAs in pushing forward the in-plan initiatives, including the catch-up contributions, employer Roth contributions and an exemption from required minimum distributions.

“The combination of tax-free earnings on qualified distributions and an exemption from required minimum distributions have proven popular with IRA savers,” she says, noting that Roth IRAs now account for $1.4 trillion, or 10.3% of all IRA assets via data from the Investment Company Institute.

Van Zomeren and Ascensus expect defined contribution Roth savings to increase via the Roth catch-up contributions and the exempted Roth contributions as participants will be more apt to leave savings in plan.

In terms of the Roth employer contributions, however, she and the firm remain skeptical as “frankly we didn’t see it as being any different, really, than Roth in-plan conversations. After several initial inquiries about when this feature would become available, we are—as we expected—hearing less and less about it as more and more of the similarities to in-plan Roth conversions became known.”

Default Future?

American Trust Wealth’s Morgan also noted the need for clarity around whether Roth can be made the default in a plan as that has “not explicitly been answered.” He also notes past efforts to cap the amount of elective plan deferrals that can be pre-tax savings, and over-and-above those caps would be treated as Roth.

“That has not been pushed through, but you can see where the direction and energy is from a legislative standpoint,” he says. “Certainly, I think as long the federal deficit is a key sticking point; that will continue to be the trend.”

Vestwell’s Gaston notes the longevity of Roth, which was first proposed by former Senator William Roth, a Republican representing Delaware, in the late 1990s to tax-qualified retirement savings upfront.

“It’s amazing how it has really stuck with us,” Gaston says. “Here we are relooking at Roth again as an important tool.”

He says plan advisers should definitely be discussing the various Roth options with plan sponsors more often in coming years.

“Implementing Roth options are often good ideas, not mandatory ideas,” he says. “Which is exactly the kind of thing an adviser will want to be bringing to clients.”

Ascensus’ Van Zomeren agrees that education and advice will be key to implementation.

“There is not a one-size-fits-all-answer [for participants],” she says. “Optionality, now in both defined contribution plans and IRAs, should bode well for increasing retirement savings overall if savers aren’t too overwhelmed with the choices and intricacies of the alternatives.”