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WASHINGTONAnother obstacle blocking employers from adding Roth 401(k) plans has been lifted, but widespread employer adoption of the plans is at least several years away.
Last week, the Internal Revenue Service finalized regulations that largely mirror rules it proposed early last year shortly after a provision in the 2001 federal tax law that authorized Roth 401(k) plans went into effect.
The final rules, though, do clarify several points affecting the arrangements under which employees make after-tax contributions--unlike traditional 401(k) plan contributions. Then, as long as certain conditions are met, employees can withdraw investment income earned on the contributions tax-free.
One clarification involves employees who terminate employment and have small balances in their traditional 401(k) and Roth 401(k) accounts.
Under federal law, if a pension or savings plan distribution is between $1,000 and $5,000 and the employee hasn't told the employer what to do with the money, the employer--unless it decides to keep the money in the plans--must transfer the funds to an individual retirement account it selects.
The final regulations make clear that terminating employees' Roth 401(k) and traditional 401(k) account balances can be kept separate to determine if the $1,000 rollover threshold was hit.
For example, if a terminating employee had $800 in his or her Roth 401(k) account and $600 in his or her traditional 401(k) account, the employer would not have to transfer the balances to an IRA. Instead, the employer could simply cut distribution checks to the employee.
The other clarification involves 401(k) catch-up contributions. Under federal law, employees 50 and older can contribute an extra $5,000 a year to their 401(k) plans. The final regulations make clear that catch-up contributions can be made to Roth accounts. The $5,000 limit would remain the same and employees would decide what portion, if any, of their catch-up contribution would go to their Roth or traditional 401(k) account.
With final rules in place, employers now have the regularity certainty they need to operate the plans. That comes about nine months after Congress eliminated the biggest obstacle that stalled adoption of the plans: making the plans permanent, which legislators did last year as part of a pension funding reform bill.
Without the change, the provision in the 2001 law (see sidebar) creating the accounts would have expired at the 2010. That uncertainty about the accounts' future had resulted in many employers staying on the sidelines.
"You wouldn't want to do all the work knowing that Roth plans could sunset in a few years," said Kyle Brown, an attorney with Watson Wyatt Worldwide in Arlington, Va.
With the future of the plans decided and final rules in place, experts expect employer adoption of the plans to pick up, though only slowly.
The plans will "become more mainstream," but it will take a while, said Pam Hess, director of retirement research at Hewitt Associates Inc. in Lincolnshire, Ill.
So far, the employer takeup rate has been "pretty slow," said Michael Weddell, a principal at Mercer Human Resource Consulting in Detroit. Experts put the employer adoption rate between 5% and 15%.
Others factors holding back employer adoption of Roth plans have been time constraints as they have had to deal with other more pressing pension-related issues, such as evaluating whether they should freeze their defined benefit plans and enhance their 401(k) plans or add an automatic enrollment feature to their 401(k) plans.
"Other projects have had a higher priority. That doesn't mean Roth adoption won't happen, it just isn't going to happen overnight," said Rachel Kugelmass, a director with Affiliated Computer Services Inc. in New York.
Low participation rates
Still, some employers have shied away from the plans because they are not convinced that a meaningful percentage of employees would participate.
For lower-paid employees, potential tax savings in the future pale in comparison with the need to use current income for more immediate family needs, said Lea Gerber, director of risk management and benefits at Elixir Industries, a diverse manufacturer in Mission Viejo, Calif.
Employers that have added Roth accounts to their traditional 401(k) plans report very low participation. For example, at Chicago-based Hartmarx Corp., only about 3% of eligible participants made contributions to Roth accounts last year, despite a robust communications program. Possible reasons for the low participation rate include the newness of the program and that employees tend to be more focused on immediate tax deductions, said Michael Pikelny, corporate actuary and employee benefit consultant.
Other employers, though, report higher participation rates. For example, at A.G. Edwards & Sons Inc., 11.3% of eligible employees made Roth contributions last year, with employees contributing an average 8.3% of pay to the accounts compared vs. an average 8.9% in the company's traditional 401(k) plan, said Roger Elbert, manager of employee benefits in St. Louis.