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. We already have a number of retirement vehicles available for most people, but there are still millions of people who simply don’t save anything for retirement. One of the less 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 an old issue of Newsweek. Jane Bryant Quinn addresses the topic with a fairly 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 don’t make much money and are 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.
Quinn’s article was before the new Obama administration’s new proposal which throws another wrench into the mix by defaulting to a Roth IRA as the automatic enrollment vehicle. Now there’s little tax break up front but a tax break in the future. For lower income individuals I think they would see more value of an immediate tax break. A Roth still probably makes more sense for them financially, but the idea is to encourage people to save, period. If they can’t envision the tax break 30 years down the road they may see little benefit to contributing at all, and the whole premise of the automatic IRA has been wasted.
Here’s how the automatic IRA would work in a nutshell:
- Employers without retirement plans and have 10 or more employees and have been in business for at least two years would be required 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, but the automatic enrollment would default to 3%.
- 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? I guess if you’re creating an opt-out plan instead of an opt-in plan you will get a lot of people to enroll and never opt out. It could be just due to apathy, but at least there would be people saving who otherwise might not be. But there is one issue that bothers me, and that’s the details around liability and fiduciary duty.
If the employer isn’t responsible, who is? Who do they select for the IRA provider? Will the government select a dedicated investment provider? Will they be responsible? No. Remember, these are Individual Retirement Accounts. Everything falls on the individual for making decisions. Who is going to provide them with investment advice? Who is going to help them understand the importance of saving? Who is going to guide them when an employee gets fired or quits their job and wants to cash out all this “found money” they now have access to? And what about help with roll overs? I’m sure a lot of employers would love to wash their hands of any fiduciary responsibility, but this isn’t doing the common employee any favors.
A Good Idea on Paper
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’ve worked with retirement plans and my sole job was 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 stay enrolled in an IRA that has no match and comes with virtually no guidance?
We still don’t have standardized automatic 401(k) enrollment, which would help millions more people and is an infrastructure that is already in place, so why don’t we start there?
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 any different other than making it an opt-out account. 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. Some may obviously not realize they are saving or never get around to opting out, but for people who are literally living on every last penny of their paycheck will likely just opt out so they can get more money, especially if they aren’t seeing any financial incentive for saving.
The real way to get lower income workers to save is to give them free money. Those earning more money obviously get a nice tax deduction by saving in pre-tax retirement accounts, but when you have someone that isn’t paying any tax as it is there’s not much incentive. That’s where the saver’s tax credit comes in. This is a credit for those those who contribute to an retirement account with low incomes. Again, this is a great incentive for lower income workers, yet very few actually take advantage of it. It’s a tax break specifically for the working poor and it usually goes to waste. At least if the IRA became an automatic enrollment you could find a way to show these savers how much of a credit they would receive in order to encourage them to stay enrolled, but I usually find that trying to manipulate financial behaviors of those who make little money is not very effective.
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. The majority of employers already offer a retirement plan and most companies struggle to get employee participation over 70%. So, why not start with automatic 401(k) enrollment? I wish I had the solution to the problem, but I don’t. I just don’t think a plan like this is ultimately very helpful or addresses the real problems.
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.