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Tax-free retirement income is possible

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05-21-2006

 by Denise Trowbridge, THE COLUMBUS DISPATCH

Contributors to Roth 401(k) accounts pay Uncle Sam upfront Jennifer Monnin used to stash 8 percent of her salary in her company 401(k). Now she is down to 2 percent, but not because she's stopped saving for retirement. She's just changed the way she's doing it.

Six percent of her salary now goes into a Roth 401(k), instead. Monnin's employer, Nationwide, added the Roth 401(k) to its retirement-savings options in January.

The Roth 401(k) allows workers to sock away after-tax dollars for retirement. The money, and any gains on it, can be withdrawn tax-free during retirement.

A traditional 401(k) is funded with pre-tax dollars. Workers get a tax deduction now but pay income tax on any withdrawals they make once they retire.

"The Roth is an attractive option, because you can make an investment, then never pay taxes on it again, ever," said Hubert Bromma, chief executive of Entrust Group, a retirement-plan consulting service based in Oakland, Calif.

But American workers and companies have been slow to embrace the new account.

A survey by the Profit Sharing/401(k) Council of America found that only 17.4 percent of U.S. employers offer or plan to offer a Roth 401(k) to employees in 2006.

Roth 401(k) accounts were created by the Economic Growth and Tax Relief Reconciliation Act of 2001 to encourage workers to save more for their retirement in the face of a shaky Social Security system and a low national savings rate.

Companies were legally allowed to offer the Roth option as of Jan.1, 2006, but they have been slow to sign on, citing added administrative costs and a sneaking suspicion that workers won't line up to contribute to the new accounts.

Only 6 percent of Nationwide's 33,000 employees have signed up for the Roth 401(k) option, and most of those aren't saving additional money for retirement.

Like Monnin, they're simply dividing the amount of money they would have saved anyway between the two types of accounts.

"It's not as appealing to rank-and file workers because it's after-tax dollars," said William K. Burton, financial planner and president of Capital Investors Advisory Group in Columbus.

The average person's take-home pay will be lower than it would if you contributed the same amount to a regular 401(k), which discourages saving, he said.

For example, someone earning $60,000 a year who contributes 6 percent, or a total of $3,600, a year to a Roth 401(k) instead of a traditional 401(k) would have $20 less in their take-home pay every two weeks.

"If you're on a pretty tight budget, the added cost may reduce the amount you're able to put into the account," Burton said. "And if you put in less, that's less money working for you down the road."

Companies also seem to be in no rush to add the accounts to their benefits packages. Most are taking a wait-and-see approach.

"Their biggest concern is that it will complicate things for employees," said John Ameriks, senior investment analyst with Vanguard, America's third largest 401(k) plan provider.

Only 100 companies have added Vanguard's Roth 401(k) plan to their benefits packages, although another 300 are considering it.

Many companies don't want to mess with the added administrative work and expense if employees aren't going to participate, Bromma said.

They might have reason to sit tight.

Most workers aren't even making the most of their regular 401(k). A Harris Associates study found while 70 percent of eligible U.S. workers contribute to company-sponsored 401(k) accounts, 22 percent don't contribute enough to get their full company match. A total of 23 percent plunk away a paltry 1 percent to 4 percent of their salary.

Overall, 23 percent of 401(k) accounts have a balance of less than $5,000.

Currently, Cardinal Health and American Honda Motor Co. are reviewing the Roth 401(k), but haven't decided whether to sign on.

"When we add something to our benefits package, it's an implied endorsement," said Ed Miller, American Honda Motor Co. spokesman. Honda employs 16,000 people in Ohio. Before adding something new, "We evaluate it and make sure the benefits are clear," he said.

Other companies are shying away completely, saying the Roth 401(k) will be a "nightmare to administer," Bromma said.

"It's one more bucket of money to account for, and the IRS and the Department of Labor have been slow to give companies the tools and rules to run the plans."

But at a time when Americans aren't saving enough for retirement, having an added option is important, and Roth 401(k) accounts could be a boon for workers across the age and income spectrum.

The accounts could benefit young workers, as well as lower and middle-income earners who are in a low tax bracket now but who expect to earn more money in the future, Ameriks said.

For them, the money they put into a Roth now would be taxed at a lower rate than contributions taken from future earnings.

The plan also benefits wealthy earners who aren't eligible for a traditional Roth IRA because of the salary cap. Under current rules, annual Roth IRA contributions are limited to $4,000, and phase out as incomes top $100,000 to $160,000.

Individuals can contribute a combined total of up to $15,000 a year to Roth 401(k) and traditional 401(k) plans, plus an additional $5,000 in catch-up contributions if they are older than 50.

The new Roth clears the way for dedicated savers to sock away even more for retirement, but the potential tax benefit is the real appeal.

"The bottom line is nobody knows what's going to happen and it makes sense to hedge your risk anyway you can," Ameriks said. "Tax diversification is another way to protect yourself."

That's the appeal for Monnin.

"I have no idea what the world is going to be like when I retire, so diversifying my tax treatments is extremely important to me," Monnin said. "The boomers are aging and the deficit is growing, and one day the bill is going to come due.

"I like the idea that I can put my money where it won't be taxed."