The Trump Administration might need to ramp up its Roth education if it hopes to successfully sell its tax reform package.
This finding is relevant given the potential “Rothification” of the 401k and defined contribution market through tax reform.
In a 2017 Cerulli survey, approximately 1,000 DC plan participants were asked to select the data that best described Roth contributions. It showed that only one-third of participants correctly identified the benefits of Roth contributions—contributions are after-tax, money grows tax-free, and no taxes are paid when withdrawn at retirement.
“Individual tax deductions can be tools by which the government encourages Americans to spend or save,” Jessica Sclafani, associate director at Cerulli, said in a statement. “As it relates to retirement, the current tax code allows taxpayers to deduct retirement savings and delay paying taxes on traditional accounts—as opposed to Roth—until the savings are withdrawn, thereby encouraging individuals to build a nest egg to fund their retirement.”
This incentive would no longer exist if tax reform succeeds in Rothifying the DC market and could dramatically change Americans’ retirement savings behavior, she argued.
Given the lack of understanding of Roth contributions, the behavioral challenges associated with taxable contributions and the loss of the immediate tax benefit, or incentive, Rothification could cause some individuals to reduce or cease their contributions to an employer-sponsored retirement savings plan.
“Cerulli believes that there are some counter-initiatives that record keepers and consultants can consider to get in front of tax reform and the potential threats it poses in terms of reducing DC plan contributions,” Sclafani concluded.
These include implementing the switch to a Roth system on a non-elective basis for participants, emphasizing “the power of an employer matching contribution” within the context of a Roth system, and framing a tax break as a salary raise and an opportunity to increase retirement plan deferrals.