By: Rachel Haig
August 6, 2010
Experts at think tanks on both ends of the political spectrum embrace the idea (which Democrats will soon propose), but businesses are balking.
It's no secret that most Americans haven't saved enough for retirement. The Wall Street Journal recently reported that half of all U.S. families have no retirement savings whatsoever, meaning they will rely on Social Security benefits to cover living costs in retirement -- a dreary situation considering that the average Social Security payout is about $11,000 a year and the system is already under duress.
Obama and automatic IRAs
The Journal reports that even among Americans who do have retirement savings, many have not saved enough to cover a substantial portion of retirement -- half have socked away less than $25,000.
The Obama administration and congressional Democrats are pushing for "automatic" individual retirement accounts as a way to begin addressing widespread savings shortfalls. The Hill newspaper reported that Democrats will soon propose legislation making IRA enrollment automatic for private-sector employees whose employers do not offer a retirement savings option. Workers would be allowed to opt out.
A proposal for automatic IRAs has come from think tanks on opposite ends of the political spectrum -- The Brookings Institution and the Heritage Foundation have cooperated on the Retirement Security Project (.pdf file). Think-tank collaboration hasn't spilled over into broader bipartisanship, however, and interest groups remain divided. AARP is lobbying for automatic IRAs, while business interests are opposing the idea on the grounds that it would raise employer costs, particularly for small businesses.
The problem of retirement savings is deep and won't be resolved with a single proposal. But the automatic IRA is worth a closer look to see if it would prompt more Americans to save.
What are automatic IRAs?
It's impossible to know exactly what automatic IRAs would look like until legislation is finalized, but the general idea is to provide a savings vehicle similar to a 401k for workers whose employers do not provide a retirement savings option. According to Brookings and Heritage, nearly 78 million people, or about half of all U.S. workers, fall into this category.
Employers would automatically enroll eligible employees in an IRA plan, then withhold a set amount from employees' paychecks and place it in the savings account.
As proposed by the Brookings and Heritage, the default arrangement would be for employers to choose a single IRA provider for all employees, much as they now do for their workers' 401k plans. Employers could opt to allow each employee to select a provider.
Employees would have the options of opting out, or raising or lowering the contribution set by their employer. Workers could also choose where to invest from a menu of options.
Proponents argue that automatic enrollment will shift the pull of inertia toward saving; if employees do nothing, they will be saving for retirement.
The most likely default investment would be a target-date fund or some other diversified investment rather than a stable-value or money market fund.
Considering that inertia is a big argument for automatically enrollment, it may make sense to direct employee investments into target-date funds, which require minimal employee engagement. The downside, however, is that some employees may not understand the level of risk they are taking on.
Would people actually save more?
Brookings and Heritage argue that automatic enrollment would raise participation, as happened with the introduction of 401k's, which have participation rates of between 85% and 95% when automatic enrollment is used, compared with 75% before automatic enrollment.
Think tanks estimate that automatic IRAs could increase annual retirement savings by nearly $8 billion.
Making IRA contributions happen by default addresses the problem of employees not saving because of apathy or the belief that doing so would be too complicated. Still, automatic IRAs would have the same contribution limits as traditional and Roth IRAs (currently $5,000), not the higher 401k limits. Automatic IRA proponents hope more employers would eventually offer additional retirement-savings options, such as 401k's, to their employees.
There is also the issue that some workers may simply not have enough money to save, and others may not view saving for retirement as a priority.
With tax credits, the Obama administration is trying to provide the incentive to save, but addressing Americans' lack of retirement savings will require years of persistence.
Would they be too costly for employers?
Opponents of automatic IRAs argue that such vehicles impose extraordinary costs on employers. However, the only requirement for a business implementing automatic IRAs would be that it divert a portion of an employee's pay into the account. Employers would not have to sponsor an investment plan.
David John of the Heritage Foundation argues that small businesses would not have to do much at all. "They need to do little more than they do now with the income and payroll taxes they deduct from an employee's paycheck and send to the IRS," he says.