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READER RADAR: (How) Would a Roth Option for Employer Contributions Work?

DC Plan Design

One of the revenue-raising provisions currently in the Enhancing American Retirement Now (EARN) Act is a provision that would permit an employee to elect to treat employer matching and other employer contributions as after-tax Roth contributions. What do NAPA-Net readers make of this?

Now, being in that legislation now—and making it into the final (not to mention the inevitable reconciliation with the version passed by the U.S. House of Representatives)—isn’t a sure bet. But it is projected to raise some $12 billion in revenue for the government (people opting to pay taxes now with the embrace of a Roth alternative)—and so… well, you just never know. But—assuming it gets to law, and while employers would presumably still get the tax deduction for the contribution, plan sponsors would have to amend their plans to allow it—and with concerns about inflation and future tax rates high, this week we asked you what you thought… 

Plan Sponsor Preferences

First off, and generally speaking, would plan sponsor clients allow/encourage participants to do this?

35% - Some would.

31% - A few might—but vast majority wouldn’t.

22% - Yes, most would.

8% - Yes, I think they all would.

5% - I don’t see any interest for this kind of thing.

We also got some interesting comments—a sampling:

As long as they can deduct, I am sure they don’t care what tax status the employee takes it in.

I think it depends on a few things. 1) Does the employer or participant pay the taxes on matching contributions? 2) Can participants elect individually whether or not to treat them as Roth?

Much like the Roth provision on employee contributions, there will be mixed opinions and understanding of a Roth feature to employer contributions

Well; the ER is looking for deductible contributions, ROTH would erase this right? The net contributions are an affordable option, but I don’t think ER’s would look at funding without deductions.

ideal for younger workers

Yes, I think plan sponsors would adopt this as long as it didn’t add a huge administrative burden on them.

I think the ability to claim a deduction is still big from and employer’s perspective...

If it would impact the Sponsor from a cost-perspective, or a large added admin burden, I think many would consider it.

Plan sponsors generally want to give their employees options, so I see most adding it to their plan. With that said, adoption will be contingent on the messaging/marketing. There should be a simple and concise explanation that lays out the potential advantages.

I think employers want to have flexibility for their plans. Who is paying taxes on the Roth Match? Does an employer get a deduction and then the employee immediately get taxed on it?

I have younger participants who are 100% Roth deferral and would like to have all money Roth if it could be. I also believe there is a subset of participants who see value in any Roth options available.

Companies with younger employees may do this.

Some would, although not sure how many employees would actually use it, but if easy to elect and then implement perhaps take up would be higher. For example, paving a safe harbor option to incent automatic enrollment into Roth deferrals coupled with Roth match as the default.

Need to see how the taxation, payroll, and vesting all come into play

Taking away the tax benefit to the employer i think would discourage a lot of employers.

I think some would allow it, but it would all depend on how their payroll system can keep track and handle the taxes correctly.

Those truly interested in having a plan to best support their employees would. The problem I see is the complications with payroll systems. I would assume that the income would be passed on to the employee most systems don’t have that ability and still show that they are treating everyone equally. The second issue would only work with the safe harbor as any vesting would create a fantom tax with dollars that could be recalled.

Plan sponsors try to minimize confusion, and this adds an extra layer

It has to do with delayed gratification. People are hard wired to want a “reward” sooner rather than later.

There is no way this could work if there is a vesting schedule associated with the match. If a participant receives a Roth matching contribution and is not vested in the match at the time of termination, then what happens? They paid taxes on a contribution that they never received and then have to amend their tax returns. Totally stupid idea that was not properly vetted and thought through - typical way Congress operates....

In California, where the tax rates are amongst the highest, anything ROTH makes much more sense. If you trust the gov’t to not go back and tax it a second time

In the private sector, having the participant elect to treat the “employer” match as Roth means the employer cannot deduct that contribution. I do not know many “for profit” small businesses that would want to have a participant determine if they can deduct a business expense. In initial discussions with many of our “for profit” clients, they are showing NO interest in this option. As for the “not for profit” world, this may have a place.

 I think we might all agree that it’s an interesting idea worth evaluating. But, on a more basic level, I would think that the administration on the payroll side will be complicated and for that reason, the client would not choose to adopt. I’d also add that there is so little usage of the Roth in almost all of our plans that this idea doesn’t raise to the level of a “let’s do it.” I still scratch my head trying to figure out why there’s so little in the way of Roth adoption. Although a Roth IMHO is a no-brainer for any young person, I think that in the end, inertia just kicks in. Another decision people don’t want to take the time to make (I’m one of them).

The employer still gains an employer contribution tax deduction (or potential credit) and the employee registers the contribution as income now to receive tax-free withdrawal later it could be perceived as a win-win. As a participant elected option, the take-up could be low, but Roth started small in the beginning too.

Those that have external payroll companies would care less; however, internal payroll is going to push back a bit. Employees will not embrace this unless they are highly educated and are making enough money to pay those extra taxes.

It would create more taxable income and therefore more payroll taxes for employers. Most will opt not to allow it.

WAY too confusing...

Biggest question would come down to the corporate tax treatment of allowing the plan sponsor to make Roth ER contributions.

Most participants would likely pass on this, as they would not be interested in increasing their taxable income during the current tax year, but rather defer this to retirement. I believe many will appreciate the ability to have options when getting to retirement, both Roth and traditional contributions create distribution options.

If it is an optional statutory provision, the level of administrative work and communication work may not be worth the effort. At the very least, the employer should review how many employees have opted for ROTH already, if the savings plan offers one.

So far, the plan sponsors I have talked to about it, and assuming they would foot the bill for the tax, have said no way.

It will not happen overnight. It will take some education for plan sponsors and ppts. Would the plan sponsor still receive some type of tax break? This would need to be spelled out. For the participants, since they didn’t receive a tax break anyway upfront -- this makes a lot of sense.

I don’t think employers will think enough participants will be interested to complicate their plans.

This is ridiculous from an administrative standpoint. The sponsor would have to get an election from those choosing to do this (I’m assuming the default election would be pre-tax, and that the regulations wouldn’t require an election from every participant either way—but you know where assuming gets you), and then be sure to deposit those participants’ match/profit sharing into the correct source. Too much extra work and room for error.

This is a no-brainer to add. Would also make it more attractive for employees if their employer offered this. As an employee I would view this as an additional benefit.

I think most clients that currently offer Roth deferrals and in-plan Roth conversions would offer this provision.

Participant Perspectives

And then, assuming it was offered, we asked readers if they thought there would be participant interest in treating employer matching contributions as after-tax Roth contributions? Once again, the responses were varied:

55% - Some

23% - Little

21% - Lots

1% - None at all

And some comments…

Assuming they can afford the taxes… makes sense to double down

Similarly, participant understanding and implementation of Roth will be mixed for both opinions and understanding.

An Informed employee would want the additional GROSS funding... (more in my pocket!)

With enough education, I believe employees would do it too.

If we included it in our participant education, there would be a decent % adopt this

A lot here falls on education and engagement, but with the deficit and high government spending, there will likely be more talk about the need to increase taxes and Roth being more beneficial to more participants. You’d be surprised how many participants currently think when they make a Roth deferral contribution that the corresponding employer match is also Roth. So education will be important.

Younger people might consider this. I have a client on Empower and when the younger people select Roth versus K, it changes their retirement score. If they could do the same with employer contributions and see the result, they would most likely do it.

Definitely some interest, especially as Roth deferrals have grown. Have been educating and pushing for Roth usage for a long time, the question about match has always been brought up as most employees think that’s what naturally happens anyway. They don’t necessarily realize the tax consequence on the match piece, but once you describe how it works, several are interested in doing in-plan Roth conversions.

it is an easy incremental way to get Roth, hopefully via payroll taxation. Vesting is an issue.

I’d say depending on the demographics of the company I could see a lot of rank and file employees participating if they don’t need any deductions.

Vesting becomes the challenge.

Once they understand how’ll they’ll be taxed on the contribution now, and then see the impact in their take home pay, that could change their mind quickly. We also know that there is still a benefit to have some pre-tax dollars in a retirement account

I think mid-career professionals making good money would do it if the concept is explained fully.

In order to see high rates of adoption, I believe it would require some mechanism for the tax to be collected from payroll. I’m not familiar with the pending legislation, but if the legislators believe participants will just write a check at the end of the year to cover the tax, they’re as wrong as they were with the Roth In-Plan Conversion. Both are great options, but the general participant doesn’t set aside enough to have the tax covered, so they likely would not take advantage of the option. If there is a way to take it via payroll, take an estimate of the employer contribution (only deposit 80% of the corpus, for instance) or some other mechanism for it to be “painless” for the participant, then I believe we could see meaningful adoption of the provision.

just like Roth deferrals it will take a lot of education

Participants barely understand Roth as it is...

Small plans may do it for the owners/key employees. Plans with many employees will find it problematic—tax collection could be a real problem as the participant will have the tax burden but not may not have the money; for generous plans the amounts allocated could create real problems. What about vesting issues? Don’t know enough about how this would work yet....

I’ve had financial advisors push plan sponsors to add In Plan Roth Rollover/Conversions, and then not one participant does it. I don’t think there’s a great deal of interest in this on the participant end.

‘Personal’ Perspective

And then we asked readers if they would take advantage of this type provision (if offered):

36% - Oh, for sure.

23% - Probably not.

13% - No way.

28% - Not sure.

I did make Roth contributions earlier in my career, and am glad that I did, but for now I am making deductible contributions for the immediate tax benefit.

I would welcome the opportunity to set up future tax free income from the appreciation from the cost basis. my belief is the taxes are also going to stay at these levels or increase going forward. I’ll have to weigh all of the criteria in the decision at that specific time to determine how much of the contribution if any would be deemed Roth versus traditional employer contribution. I have contributed Roth for my employee contributions for some time.

Sure... offset the lack of deductions with a tax credit and the ER might bite.

Depends on my tax bracket that year.

I would consider it. If I was younger/earlier in my career, I would definitely have taken advantage of this option. I’d have to analyze the numbers to see if it made sense.

Depends on how it is handled tax wise from the employer side it would something to be considered.

I’d have to dig into it… self employed so not sure of the implications good or bad about it yet and I’ve only had one cup of coffee this morning so I’ve not read the legislation :)

Absolutely, the more flexibility you can make the program, the better. But we know taxes can be difficult and unless there is a way for employers/providers to assess a downpayment on that match tax on behalf of employees up front could get dicey to implement. Taking the same tax assessment on the deferral and applying it to the match on W2s would be the best way to do this in my opinion as opposed to 1099s at the end of the year.

I certainly would consider it but my retirement timeline may be a factor.

If it fits with my current tax situation.

The Government continues to use Roth for revenue generation. Once that well of conversions and current contributions runs dry, what’s next? Plus I believe that a Fair Tax could still happen in the future, which negates the benefits of a Roth.

I love the idea of free distributions in retirement. I would do it.

I think that one day the government will tax ROTH just like they tax Social Security. I don’t have any trust that the ROTH will stay. Look at the recent proposals to tax ROTH. No one in DC expects this to be a permanent tax break.

This is an expensive way of providing a participant a benefit. Instead, you could provide an additional tax deductible bonus to the participant which they could defer as Roth.

Paying taxes in my current bracket is not my idea of financial prudence...

I am a huge advocate of the Roth—esp. with longevity and the tax free withdrawals. Add on the dampening of Social Security and taxes which could be due.

Ugh—when do I take said Roth match into income? For the year for which it’s allocated? What if it’s not determined/deposited until the following September? Even if I take it into income for the year deposited rather than the year allocated, a September “reveal” doesn’t leave a lot of time for tax planning.

Absolutely! Win win. If you truly believe tax brackets will raise for same equivalent income, then it’s worth the taxes for employer contributions going into the plan for the overall benefit.

I would for some, not all of it.

Other Comments

And then, to wrap up, some final insights:

I think that Roth is particularly valuable for younger, probably college education, employees whose highest earning (and taxed) years are in the future. Then they could convert to deductible contributions and developed a tax-balanced retirement savings account.

Great idea if they can make it operationally efficient.

This can all be solved through the delivery of participant advice around this decision. Even with all of my understanding, it’s an in artful execution. If given the opportunity to defer employer contributions into a Roth budget, would either allow for the entire 4% match that my plan offers? What I do some lesser amount, or choose not to do it at all? I have to talk to my financial planner and do my own research before coming up with a final decision. I’ll probably just check the box and contribute the entire contribution to a Roth bucket at my age.

I have never liked conversions in a plan... too much work and not enough benefit, pay the taxes outside of the plan.

While I like the idea of allowing for employees to be able to elect employer match as Roth, I don’t think it will be an easy lift for recordkeepers and payroll providers. Platform enhancements will be needed and it is likely to result in more administrative issues.

I wish the government would make a portion of, if not all, employer match contributions Roth to participants without the participant having to pay taxes on the amount at all. It could be limited to 4% , which is the typical safe harbor match, and really be a boost to retirement savings. This could apply to all plans and could even be tied to deferral requirement by participant at same rate. The employer still gets the deduction, the employee has an incentive to defer since they will get a Roth match without having to pay taxes on that source ever, and everyone has a way to save money. Auto enroll @4% would be mandatory but the choice of Roth or pre-tax deferrals remain with the participant. That would be something the government could do that is a terrific replacement for those who no longer have a traditional pension plan to rely on for retirement.

Pay tax on the seed and not the harvest!

Younger people understand it, older are confused by it and conversions are mostly discussed by those with money to pay the taxes—which is not most employees.

401ks are already over complicated. Participants need as straightforward a plan as we can give them.

I did an In-Plan Roth conversion a couple of years ago, which required me to file our taxes manually as the online tax filing system was not set up appropriately to be able to file it electronically. I believe that is an IRS documentation issue a probably not an H&R Block issue. It was an inconvenience.

We continue to see an uptick in the % of eligible participants electing some or all of their ongoing payroll deductions as Roth source money. However, we see very infrequent use of the In-Plan Roth Rollovers/Transfer provisions primarily due to the need to fund the anticipated tax bill with outside assets.

More plan sponsors need to understand the value of Roth.

There are provisions in Secure Act 2.0 and the Senate Bills that would require Catch up contributions to be made as Roth Contributions. I am not a fan of that either and see no reason that the government should mandate any elective contributions as Roth.

Administratively, it would have to be easy to do through Payroll or plan sponsors won’t adopt it.

The math is always better with ROTH for any reasonable length of time. Perhaps the State IRA programs that use ROTH IRAs will make sure that ROTH stays around.

While the intent is to make the 401k plan the centerpiece of financial planning which overall is a good thing, providing more and more options requires the need for more participant education. This takes time and money and how advisors will charge for this additional education will need to evolve. Plus, many of these are tax related and outside the scope of many advisors knowledge and compliance requirements as it may need consultation with the participants tax professionals. So, decisions associated with this may take more time and/or the participant may not want to take the time to visit with their tax professional. So, they may be turned off and will want an easy button answer.

Love the concept. Big believer. So much flexibility that it provides to not only save money on a tax advantaged basis but to diversify your tax picture. We try to fully educate everyone about the possible ways a Roth might be a great option for you (for all or a portion of your account)..... in the end, we see less than 10% of the people taking advantage of that.

Cynically, I think Congress will find a way to tax Roth in the future.

There is always a strategy for everyone. it takes education and the right time for it.

Though Roth can be a nice tax diversification strategy for certain individuals, it is a source of confusion for countless others.

What is the impact to a worker’s W2 if the contribution goes in after the calendar year, for the prior tax year?

Please. Just no. What an administrative nightmare. I don’t know if I’ll be able to sleep tonight.

It would be interesting to see how the Joint Committee modeled the expected tax revenue. A more interesting question might be to find out if the match becomes taxable income to the employee, then ask Question #2 again.

The term “Back-door-Roth” is still widely misused even by some of the industry’s best (or at least most prominent) financial planning personalities. They either use it to refer to in-plan conversions/rollovers of pretax dollars.

Making retirement plans more and more complicated is not going to encourage employers who currently don’t offer one to do so.

Roth will take over. Plans that adopt this before others, if passed, will gain a lot of interest in attracting new employees or retention.

One of the concerns I have with employees opting for the Roth is that they forget that I very specifically explained that there will be a tax bill on the employer match when participants retire, and they are upset as they set their expectation for a tax-free 401k withdrawal.

Adding this type of provision would require additional education efforts to make sure participants understand the tax implications of treating employer contributions as after-tax Roth contributions. Some participants will likely think there is no tax implication without clear guidance.

Thanks to everyone who participated in our NAPA-Net Reader Radar poll