Sancho Panza, Financial Advisor

 In Retirement Planning & Wealth Management

Sancho Panza, the good-natured squire to the wandering Don Quixote in the 17th century novel by Miguel de Cervantes, had many attributes. He was loyal and wise, and gave valued though usually ignored advice to his knight. But who would have guessed he also was a bit of a sage on financial matters?

It turns out that one of our favorite sayings in financial services comes from Sancho Panza. “Don’t put all your eggs in one basket” stems from a translation of Cervantes’ original Spanish text, and in this instance we’ll use this saying to think about the idea of tax diversification.

In the retirement plan marketplace, the conversation starts and largely ends for many participants with tax-deferred assets, such as Roth 401(k) accounts. Access to Roth 401(k) accounts continues to increase, giving participants more opportunities to easily increase retirement savings and diversify their tax positions. However, we continue to see research that describes Roth 401(k) usage as “woeful.” Luckily, the research we discuss provides a number of ideas to increase participation, such as using interactive technology to better involve participants in the education process.

This idea of tax diversification is an important one. We can’t be certain what the tax landscape will look like in the future, so having access to tax-deferred, tax-free and taxable assets can provide clients with greater flexibility down the road. Ask anyone and they would begrudgingly admit that their taxes are more likely to increase rather than decrease in the future. Tax uncertainty, and more importantly, the value of Roth savings along with it, are highlighted in academic research. That value could be up to 2.1% for some investors.
Not only do we see that more of these options are available and that they make economic sense for participants, but also that the IRS has made distributions from these accounts more streamlined, which could help participants reduce taxation on distributions.

Overall, there are a number of reasons why Roth 401(k) accounts make sense. Roth 401(k) accounts can help increase retirement savings, diversify one’s tax position and help participants not have all their eggs in one basket. Just like Sancho Panza advised 400 years ago.

To learn more, read our Defined Contribution in Review Guide and Plan Talk Podcast.

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References:

  1. Notes on the translation of Don Quixote – https://herbison.com/herbison/broken_eggs_quixote.html
  2. How America Saves 2016: Vanguard 2015 defined contribution plan data – https://pressroom.vanguard.com/nonindexed/HAS2016_Final.pdf
  3. Capturing the Opportunity of Roth 401(k) Contributions: What Employees are Missing and How Employers Can Help – https://www.towerswatson.com/en/Insights/IC-Types/Ad-hoc-Point-of-View/2016/02/capturing-the-opportunity-of-roth-401k-contributions?webSyncID=331e9783-79bd-11d4-e2ab-7a940b98a79d&sessionGUID=07439cc1-2227-be4d-a1be-172e0dd7b46e
  4. Tax Uncertainty and Retirement Savings Diversification – https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2799288
  5. Guidance on Allocation of After-Tax Amounts to Rollovers (Notice 2014-54) – https://www.irs.gov/pub/irs-drop/n-14-54.pdf
  6. Tax information contained herein is not intended or written to be used, and it cannot be used by taxpayers for the purposes of avoiding penalties that may be imposed on taxpayers. Such tax information and any estate planning information is general in nature, is provided for informational and educational purposes only, and should not be construed as legal or tax advice.

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