Gen Y & Employers: A Failure to Communicate on Roth 401(k) Benefits?

Less than 20 percent of young adults lucky enough to have access to a Roth 401(k) are jumping at this tax-smart retirement savings tool. According to a new study by benefits consulting firm Hewitt Associates, just 16.6 percent of employees between the ages of 20-29 opt for the Roth 401(k). While that indeed is the biggest commitment to Roth 401(k)s among any age group, I'm wondering what the other 83.4 percent are thinking. While the debate over what to do about the expiring Bush tax cuts remains in full roil, it seems highly unlikely tax rates will be going down any time soon. That in itself could be a pretty good reason for going with a Roth 401(k).

But what really seals the deal for Gen Y is that your twenties likely represent the low-end of your earnings power. At least let's hope so. If you're in a low tax bracket today the value of using a Traditional 401(k) isn't nearly as valuable as when your earnings put you in the top tax brackets of 33 percent-36 percent. You're avoiding tax today when you are in a low rate, but when you pull that money out in retirement it may likely be at a higher income tax rate. Remember, all withdrawals from a traditional 401(k) are taxed as ordinary income, not gains, no matter how long the money has been invested.

Pay Your Tax Bill Today = Tax Free Withdrawals in Retirement
If I were a Gen Yer and had access to a Roth 401(k) I'd be eager to pay my retirement tax bill today by making after-tax contributions into the Roth 401(k). Again, I'm assuming I am not yet raking in the big bucks and paying Uncle Sam at a marginal tax bracket north of 30 percent. The payoff is that I will have 100 percent tax-free withdrawals in retirement. Going with the Roth 401(k) also will give you more control of your money in retirement. Unlike money in a Traditional 401(k) the IRS does not impose Required Minimum Distributions (RMDs) on Roth 401(k) assets once you edge past 70 ½. I realize Gen Y might not be in legacy-planning mode just yet, but that can mean leaving more money to your heirs.
Better Explanations Needed I'm guessing that part of the reason for the slow uptake among Gen Y is partly due to a lack of compelling education by plan sponsors. It's not exactly intuitive to pass up what looks enticing today-the benefit of contributions being made on a pre-tax basis-for what can likely be a much bigger tax break in retirement: tax free withdrawals from a Roth 401(k). But that education seems the least employers could offer up to its Gen Y staff that is already having a hard enough time: salaries haven't exactly been skyrocketing and if older employees make good on their threat to delay retiring, Gen Y might be stuck on the lower rungs of the ladder longer. Helping Gen Y at least optimize their retirement saving, by investing the resources to fully communicate the potential benefit of a Roth 401(k) seems like a pretty small way to give Gen Y a much-needed boost.

The more plans that do a better job explaining the value of a Roth 401(k) could also have a huge impact on the ability of more employees to gain access to a Roth 401(k). Hewitt reported that just 29 percent of plans surveyed currently even offer a Roth option within their 401(k). If I'm the other 71 percent of plan sponsors still on the sidelines, looking at the low uptake of the Roth option among Gen Y-the age group most likely to benefit most from the Roth-it might reduce my eagerness to go through the time and effort of adding it to my current plan. That would be a shame. The Roth 401(k) is a terrific retirement option, especially for younger adults.

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