Newer Participants More Likely to Use Roth

A working paper released by the National Bureau of Economic Research (NBER) attributes this to participant inertia, saying once an employee joins a 401(k) she becomes passive/inattentive, thereby reducing the likelihood of reacting to the introduction of a new Roth option. “The low usage of the Roth 401(k) may reflect an active preference against the Roth, but it can also be partially explained if employees who enrolled in the 401(k) when the Roth was unavailable fail to update their 401(k) elections in response to the introduction of the Roth,” the authors wrote.

The authors explain that Roth contributions are advantageous to households whose current marginal tax rate is lower than their marginal tax rate in retirement. If households understand this fact, then it would be expected that younger employees are more likely to allocate contributions to the Roth. Employees with transitorily low income would also be expected to utilize the Roth 401(k). If households are uncertain about whether their marginal tax rate will be higher or lower in retirement, they may wish to hedge this risk by contributing to both Roth and pre-tax accounts in their 401(k).

Using administrative 401(k) plan data from twelve companies that introduced a Roth 401(k) option between 2006 and 2010, the report authors find that approximately one year after the Roth has been introduced, 8.6% of all 401(k) participants have a positive balance in their Roth account. Roth balances make up only 1.8% of total 401(k) balances at these companies on average. Consistent with the existence of a tax diversification motive, 54.8% of employees who contribute to the Roth also contribute to another 401(k) account.

Supporting the importance of the passivity channel, the authors found 19.0% of 401(k) participants who were hired after the Roth's introduction have a positive balance in the Roth approximately one year after its introduction, compared to 7.9% of 401(k) participants hired before the Roth's introduction who have a positive balance in the Roth.

According to the report, those with positive Roth balances are younger and more likely to be male. Higher-salary workers are less likely to have a positive Roth balance among 401(k) participants who are post-Roth hires, but more likely among 401(k) participants who are pre-Roth hires. The authors say this negative correlation among post-Roth hires is consistent with the Roth being more attractive to workers in temporarily low current tax brackets. However, once age is controlled for, salary has at best a weak association with Roth usage in this group.

The positive correlation among pre-Roth hires may be explained by a negative correlation between income and passivity, which would cause higher income employees to be more likely to update their 401(k) elections in response to the Roth's introduction. There is likely also a positive correlation between income and financial literacy, including knowledge of the rules that govern the Roth 401(k).

The working paper can be downloaded from http://www.nber.org/papers/w19193. A free subscription may be required.