Your Employees are Underutilizing the Roth Option for the 401(k)
June 14, 2016


Not all of us are fortunate enough to have access to Roth 401(k) accounts. Only a fraction of employers who offer 401(k) plans make Roth accounts available to their employees. But recent surveys indicate that even when Roth accounts are offered, employees have yet to embrace them. Fewer than 10 percent of plan participants who have an option to make contributions to a Roth 401(k) account actually do so, according to research by the Society for Human Resources Management. 

And that’s a shame.

Millennial employees now represent the largest age group in the work force – and they are in a position to benefit tremendously from participation in a Roth 401(k) account. If your younger, ambitious, promotable employees aren’t putting serious money away in a Roth 401(k), those of you in HR, and in company management, are letting them waste a golden opportunity.

Here’s why:

Employees in their 20s and their 30s are earning much less income than they will in future years. That means that they are likely in a relatively low marginal tax bracket – and the vast majority of their incomes are in the lowest tax brackets in the tax code – resulting in a  low effective tax bracket as well.

If they have reason to believe their incomes will be higher in their retirement years than they are in their desperate generic macaroni-and-cheese-eating, student-loan-repaying, putting-off-the-oil-change-and-new-tires hand-to-mouth 20s, then it is not in their best interest to choose to pay the income taxes likely to be in place on a higher income in 40 or 50 years when they can create a tax-free source of retirement income and contribute to it now, at their current tax rate

And that’s what the Roth 401(k) – or the Roth IRA, for that matter, is all about:

When an individual contributes to a Roth account, that money is still counted as income on their individual tax return – and shows up on their W-2s. But after it goes into that Roth account, with some narrow exceptions* it is never taxed again. 

Dividends are not taxed. Capital gains are not taxed. Distributions are not taxed, provided the money has remained in the account for at least five years.

This can have tremendous long-term advantages, especially for recent college graduates, younger employees and those who are upwardly mobile. American Funds, a prominent mutual fund company, has a terrific comparison tool on its website so you can see the difference for yourself. Many companies that act as 401(k) custodians provide similar tools.

Another advantage: Roth 401(k) accounts typically allow more flexible rules regarding hardship withdrawals than traditional 401(k)s. In a pinch, it’s easier for your employees to access their money in a Roth 401(k) than in a traditional tax-deferred 401(k). This by itself may encourage more participation in the plan. Indeed, we already know that Roth 401(k) participants save more aggressively than traditional 401(k) participants: According to information from the Society for Human Resources Management, workers saving to a Roth account contributed an average of 10.2 percent of their salary in 2013, compared to just 7.7 percent of salary for non-Roth savers. 

Furthermore, there will be no required minimum distributions when the Roth owner turns age 70 1/2. That itself is an important advantage over traditional 401(k) accounts: The money can continue to accumulate tax free as long as the owner and potentially the owners’ spouse lives. With traditional tax-deferred 401(k)s, participants must begin taking taxable distributions and drawing down their accounts not later than April 1 of the year after the year in which they turn age 70 1/2, whether they want to or not.

Most people in their 20s don’t think ahead that far. Many of them don’t even know what a 401(k)s, or how to use it, yet. But that tax-free source of retirement income and the lack of required minimum distributions will be important to them in their later years.

Furthermore, since most employers still don’t offer a Roth option with their 401(k)s, doing so – and making sure your employees understand the benefit by selling the heck out of it – can set your company apart from the competition.

Sell it. 

Offering the Roth 401(k) can be a great way to let your younger, millennial workers know you care about them and you’re looking out for their long-term interests. But you have to work at it – otherwise the lousy 10 percent participation rates will continue, and that’s a waste.

The first sell might be to the company’s management. If you can sell the idea of offering the Roth 401(k) to them, then you can sell it to the work force. The rollout is an excellent time to reach out to employees and ensure they understand the benefits, and how to enroll.

Place inserts in your new hire/onboarding information.

Put the fact that you offer a Roth option on your careers page on the Web. Put it in your job listings. It’s going to appeal to the smartest, most sophisticated and forward-thinking of the Millennial generation – precisely the ones you want to hire.

Explain the benefits of tax diversification: The Roth is a great way to hedge against future tax increases.**

Prepare a FAQ on Roth 401(k)s, including the use of rollovers to convert current 401(k) balances to Roth 401(k) balances. Address what happens to matching contributions (these generally remain tax-deferred, rather than taxable, even when the employee contributions are going to a Roth account.

Emphasize how most employers still don’t offer the Roth option, but how it’s a great benefit for younger workers just starting their careers.


*One exception would be the unrelated debt-financed income tax, or UDIT, which would apply if they borrowed money to use within a self-directed IRA or 401(k) account. Most HR departments will never have to worry about this, however.

**Yes, we understand that what Congress has given, Congress can take away. It is possible that future Congresses will pass a tax on Roth IRAs. However, that hasn’t happened yet. If it does, we believe there will likely be grandfather provisions of some sort, or that the tax will be focused on so-called “jumbo IRAs” worth $5 million or more. Meanwhile, we have to go with the tax code that’s actually on the books rather than the tax code we might have many years from now.