Roth Won’t Remedy ‘Pass-Through’ Problem

A recent headline suggests that a Roth election could “mitigate” the retirement plan issues identified with a mismatch in tax rates for pass-through entities – but that falls well short of solving the problem created for small business retirements.

A recent article on the PLANADVISER website quoted the opinion of an advisor who suggested that this adverse effect of the mismatch in tax rates could be mitigated by simply offering a Roth election. But there’s a big bottom-line difference between mitigating and resolving a problem.

The issue, as has been pointed out in previous posts and ARA outreach activities, is that the tax reform bill being considered by Congress could have significant adverse effects on the formation and maintenance of small business retirement plans for businesses organized as pass-through entities (Sub S corporations, partnerships and sole proprietors). Retirement plan contributions for the owners of these businesses are at a financial disadvantage. This is because of the mismatch in tax rates that occurs when a retirement plan contribution is applied as a deduction against income that would have otherwise been taxed at the lower pass-through rate but will ultimately be taxed at the higher ordinary income tax rates when distributed from the plan.

Unfortunately, the Roth option touted in the PLANADVISER article does not come close to addressing the problem. First, a Roth election, at best, can only apply to the elective contributions made to a 401(k) plan. There is no Roth option for matching contributions or discretionary profit sharing contributions. For a small business owner with the wherewithal to save, that amounts to $36,000 this year.

More to the point, as those who work with small business owners and plan designs beyond the 401(k) know, there is no “Roth” election whatsoever with regard to contributions made to a cash balance plan (or any other type of defined benefit plan). Cash balance plans are extremely popular with small business owners who, after plowing money into their business for many years, can finally start funding their retirement.1

Projections show that over 15 years, the owner of a pass-through business would be $40,000 better off by paying the lower pass-through rate rather making a $60,000 cash balance plan contribution. And none of this speaks to the impact on those who work for that small business who won’t be covered by a retirement plan that the small business owner declines to offer or maintain because of the impact on their personal financial situation.

That’s why the American Retirement Association continues to emphasize that we need your help in reaching out to Congress to fix this problem. Workplace retirement plans are the way American workers save for retirement. Small business employees are 15 times more likely to save for their retirement if they have access to a retirement plan at work.

We don’t just want to “mitigate” the impact – we need to fix it for small business owners and those they employ. And we need your help.

Tell your representatives to fix this problem ASAP – and to leave retirement alone. Go to, where you can find the necessary information to easily and quickly reach out to your elected members of Congress!


  1.  Indeed, a recent article on PLANADVISER cites data from Kravitz that record-setting contributions are being made to those plans, which now have more than $1 trillion in assets – with 92% of cash balance plans at firms with fewer than 100 employees.

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