Pay Me Now, or Pay Me Later

Many years ago, there was a commercial (for car oil filters, as I recall) that cautioned, “You can pay me now, or pay me later” – in other words, spend a little now on an oil filter, or pay lots later on to fix the damage done by not doing so. It’s a mantra that I’ve heard employed to encourage retirement savings – but these days it might have a new twist.

We now have a second survey of plan sponsors expressing concern about the impact that switch from the current pre-tax preferences accorded 401(k)s would have on participation.

That member survey by the Committee on Investment of Employee Benefit Assets (CIEBA) found that 78% of the 61 member respondents believed that a switch to an all-Roth system would negatively affect participation rates in their 401(k) plans. In that sense, it roughly mirrored the findings of a survey by the Plan Sponsor Council of America (PSCA) which found that more than three-quarters of the 443 employer respondents to the survey said they strongly agreed with the statement that eliminating or reducing the pre-tax benefits of 401(k) or 403(b) retirement savings plans would discourage employee savings in workplace retirement plans.1

While at least two other employer surveys are reportedly in the field and/or pending release, we (still) don’t know how participants will actually respond. However, it doesn’t require a massive leap of imagination to think that there might be a negative response of some magnitude to the federal government “taking away” the benefit of saving on a pre-tax basis that is, after all, what Section 401(k) of the Internal Revenue Code was all about.

Roth Rising?

Ironically, we find ourselves at a time when the availability of the Roth option in plans is at an all-time high, when providers like T. Rowe Price note that they have seen the biggest one-year increase in Roth contribution offerings in its clients’ 401(k) plans in 2016 – 61% of the plans for which it provides recordkeeping services – while Vanguard notes that two-thirds of the plans it recordkeeps now offer the feature, compared with 49% as recently as 2012.

Now, I realize that there is a difference between having the opportunity to contribute on a Roth basis, and having no option but to contribute on that basis. I’ve no doubt that there are individuals living paycheck-to-paycheck who would find the loss of the here-and-now tax preference to be a hardship. Individuals who, confronted with a Roth mandate, might indeed reduce their retirement savings in order to put food on the table, pay the rent, or put gas in the car so they can get to work.

Those concerns aren’t new, of course. For years they were – and in many cases still are – invoked as reasons to go slow, or go “low” on embracing automatic enrollment. Real as they may be, we also know what that means for retirement security.

Indeed, the surveys that have asked individuals about tax preferences – to the extent they are specific at all – nearly always focus on one particular aspect: deferring current taxes on contributions. The Roth advantages of not paying taxes on the accumulated earnings and the freedom from being forced to take RMDs aren’t even mentioned. Nor do most discussions about post-retirement drawdowns acknowledge that some large chunk of those retirement savings will be due Uncle Sam.

That said, it’s not as though the Roth doesn’t have its own set of tax preferences – and the closer one gets to retirement, the better they look. The odds that tax rates in retirement will be lower, particularly for younger workers, these days seems a quaint notion. Not surprisingly, Vanguard notes that nearly a third (30%) of Roth participants in Vanguard plans were in the age cohort of 34 or younger – and that’s without being defaulted in that direction.

Don’t get me wrong – like most of us, I’d rather have the choice than not. Nor would I diminish the communication challenge ahead if the long-standing 401(k) pre-tax preferences were capped or eliminated.

But of late, every time I see one of those reports about the average 401(k) account balances of those in their 60s, I can’t help but think that somewhere between 15% and 30%, and perhaps more, won’t go toward financing retirement, but will instead go to Uncle Sam and his state and municipal counterparts. And on a frequency dictated by the required minimum distribution schedules of the IRS.

And I can’t help but wonder how many plans for retirement don’t factor in that tax “cut.”

Nevin E. Adams, JD

1.  I draw comfort from the findings in both surveys that very few employers indicate that they would discontinue or diminish their current programs if a shift, full or partial, to Roth would occur.