There has been increasing discussion lately about new ways to help lower income employees who may not have access to more traditional retirement savings to begin saving for retirement. One of the most talked about ideas is the Automatic IRA. Would this new savings product really help level the playing field?
I have not really given these new IRAs much thought until I saw a very brief piece in February 26th edition of Newsweek. Jane Bryant Quinn comes across the topic with a hasty comment:
Funny–We pay a bundle to the rich to get them to save more money, but we pay almost nothing to the poor. When I say “pay,” I’m talking about the tax breaks offered for savings in retirement plans…the fatter your earnings, the bigger the government subsidy (deductions are always worth more in higher tax brackets).
Right away I see the obvious argument that yes, clearly people who make more money have to pay more taxes, so any tax breaks they receive will have a greater benefit than those who do not make much money, paying little or no taxes. She goes on to criticize the fact that people who earn more receive a benefit from saving whereas lower earners receive nothing. She claims that only the well-to-do are able to save for retirement and receive investment advice, it is a “privileged realm” she calls it.
Now introduce the automatic IRA, an option for employers who do not have a general retirement plan to offer as a benefit for their employees. Here’s how it works:
- Employers without retirement plans would be encouraged to make the new IRAs available.
- Workers could contribute on a percentage or fixed dollar amount basis just like the 401(k) counterpart directly through payroll deduction.
- Employers would have no obligations to this account, no requirement for matching money or any liability.
- They would receive a small tax credit to offset the start-up costs.
So the goal is to get lower income employees to save right? Then as far as I can tell this idea is wrong on so many levels. First, what is the benefit to the employer? A small tax credit for setting it up? As a business owner I couldn’t give two hoots about a little credit to offset start-up costs when it will end up resulting in a lot of additional work in payroll and human resources issues.
Second is the idea of having no liability when it comes to the account. If the employer isn’t responsible, who is? Who do they select for the IRA provider? Will they be responsible? No, remember these are Individual Retirement Accounts. Everything falls on the individual. Who is going to provide them with investment advice, who is going to help them understand the importance of saving?
On paper this idea sounds great. You provide an easy way for employees to make contributions to an IRA directly through payroll deduction. Why wouldn’t that help people save? Well, I think it would help a few, but it is taking on the problem of our inability for people with lower incomes to save in the wrong way.
I work with a retirement plan and my sole job is to educate employees and encourage them to sign up to the employer sponsored plan. The biggest problem I see is that even with a very generous company match, institutional funds with very low fees and a dedicated investment representative on-site 5 days a week the lower income employees still generally don’t enroll. If you can’t attract low income employees with a 100% match and professional investment advice that the high-paid executives in the same company are utilizing how on Earth will you ever get these people to enroll into an IRA that has no match and comes with virtually no investment advice?
The Real Problem
If companies providing these so-called “privileged” retirement accounts aren’t even able to enroll their lower income employees I just don’t see how the automatic IRA would be of any help. The real problem is that these employees are generally just able to make ends meet and don’t think they can afford to save. In some cases that may be true. Just because their employer lets them save easily and automatically doesn’t mean they will by any means.
Quinn concludes the article with another criticism of the tax code only giving savings benefits to those who earn larger incomes which I find frustrating. I percentage of relief is a percentage of relief across the board. If you make more that percentage will help more, if you make less it helps less. What does she propose we do when people are already paying virtually no taxes as it is? Should the government just give them free money for saving in a retirement account? They already have the saver’s tax credit for those who contribute to an IRA with low incomes. Above and beyond that she is basically arguing that we should be giving handouts to those who save and already pay almost nothing in taxes.
You can decide for yourself, but while the thought of an automatic IRA sounds like it would help these people save I think it is only a tiny improvement for this situation. Much more has to be done in the way of educating people, and for those who truly do not make enough money to save I don’t see what can be done to encourage them to save with a plan like this. I wish I had the solution.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
I'm not going to argue here, just point you to an article published in 2005 in The Elder Law Journal from the University of Illinois College of Law from James Poterba at MIT. It focuses on 401(k) plans rather than IRAs, but it is an easy read and on topic.
The link below only shows the first five pages, but it is available on Westlaw or at your local law library.
Lazy man, her argument against the credit was that the people who qualify generally don't owe taxes and she calls it "consumer fraud" since they can't take full advantage of the benefit.
While this may be true, it brings me back to the question as to what the proposed solution would be. You already get to deduct your contributions to a Traditional IRA, so if you max it out that is $4,000. On top of that if you qualify for the saver's credit you get to take a credit of up to half, or $2,000. If this happens to someone who doesn't owe any taxes or very little taxes what more can you do?
The government isn't in the business of paying people to be responsible by saving for retirement. They make it advantageous to do so but there is a point where you just can't help some people any further.
It would be interesting to see the numbers of the people who actually qualify for this credit and take full advantage of it by contributing the max to their IRAs. I would venture a guess that the number is extremely small.
She is quick to point out the flaws but offers no real solution. I don't know if there is an easy solution to this problem to be honest.
In all fairness, she admits that the automatic IRA is not an idea solution for some of the reasons I mentioned above, but she constantly drives home the fact that only the well-off people benefit from any sort of retirement savings.
Towards the Jane Bryant Quinn quote, it would seem to me that Saver's Credit could be fairly sizable percentage of some of the income of those in the lower class. Why not just increase that if the goal is to give the lower class more incentive to save? The infrastructure is already in place.