The pros and cons of adding a Roth contribution source to your retirement plan.

Traditionally, employer sponsored retirement plans allowed employees to save their contributions pre-tax. In recent years, many 403(b), 401(k) and 457(b) retirement plans have added the option for employees to save their elective deferrals as designated Roth contributions. According to Vanguard's How America Saves 2021,¹ 74% of plans by the end of 2020 offer the Roth feature.

Roth contributions are included in an employee's gross income, so they do not lower the employee's taxable income like pre-tax contributions. However when it comes time for retirement, qualified withdrawals from a Roth account are not taxable like pre-tax contributions. That means that the Roth investment earnings grow tax-free.

Whether an employee saves pre-tax or Roth, their total employee contribution limits are the same. Also the employer contributions are always made pre-tax and employee contributions are matched the same whether they are pre-tax or Roth. Also all contribution sources, including employee pre-tax contributions, employee Roth contributions and employer contributions are all deposited into the same account for the employee and tracked separately on their statement.

Pros of adding Roth

Additional Investment Options

The demographic of your employees is a key factor in determining whether the Roth feature makes sense for your retirement plan. Roth contributions are especially powerful for employees that are far away from retirement, because they have more time for their contributions to grow and that investment growth will be tax-free. In contrast, employees closer to retirement are usually in their peak earning years and have less time for their contributions to grow. Therefore, those employees generally use the pre-tax option to get the tax deferral. However, if you have many younger employees, the Roth option might be a great fit.

No income limitations

Roth designated accounts in an employer sponsored plan offer a unique opportunity. Usually there are income limitations restricting who can contribute to a Roth IRA. However, there are no income limits for Roth contributions into an employer sponsored plan, like a 403(b) or a 401(k).² Therefore a Roth designated account in an employer sponsored plan might be the only way some of your employees could save Roth contributions.

Cons of adding Roth

Amendment cost

Plan administrators must also be careful to track whether an employee chose pre-tax or Roth for their elective deferrals and to input that properly with payroll. However, if your plan has full 360 payroll integration between your payroll provider and your retirement provider, then this would not add to your administrative burden.

Administrative burden

When deciding whether to allow Roth contributions, first consider the demographic of your employees. Roth contributions are especially helpful for younger employees and employees in a high income tax bracket that would prevent them from setting up a Roth IRA on their own. However usually there is a cost to amend your retirement plan document and some administrative burdens to consider. Whether you decide to add the Roth feature or not, it is something many employers are considering.

1. https://institutional.vanguard.com/how-america-saves/overview.html
2. https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts

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