The rising support for Auto IRAs could be a lifeline for millions of workers saving for retirement.
What is an Auto IRA?
An Automatic Individual Retirement Account, or Auto IRA, is a retirement contribution plan available to workers without employer plans in some states and cities. An Auto IRA is not a new type of retirement savings account, but instead a new way to encourage savings in already common IRAs.
Unlike 401(k)s, 403(b)s, and other employer sponsored plans, IRAs are owned not by employers but by employees. This means new employees are not subject to eligibility requirements to start saving. Additionally, these accounts are in the hands of workers, who can direct portfolio investments, typically into a target date fund. When an employee with an IRA steps away from work, the full account value will go with them.
While IRAs are nothing new, Auto IRA savings plans are something never before seen. In states with an Auto IRA program, companies above a specific number of employees (usually five to 10) must offer a retirement plan or enroll their employees in the state’s Auto IRA program. The employee is then eligible to defer compensation into their IRA from each paycheck. This ‘automatic’ part of Automatic IRAs allows employees to save for retirement without having to think about it.
Another interesting feature of some state plans is that savings are automatically invested, if not elected otherwise. Since investing is an important part of saving for retirement, the provision positions participants to grow their savings.
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Why do Auto IRAs matter?
Auto IRAs provide new savings opportunities for marginalized and non-traditional workers across the nation. For the nearly 55 million workers who don’t have access to an employer retirement plan, Auto IRAs are a new tool to increase retirement savings.
Experts believe that while income inequality is a large part of the racial wealth gap, employee benefits may also contribute. By making retirement saving more accessible, Auto IRAs are likely to have a positive impact on financial wellbeing for many Americans.
With the rise of the gig economy comes an increase in workers ineligible for retirement plans. Many plans prohibit an employee working less than 500 hours per year to join their employer’s retirement plan, and 1099 employees would be similarly affected when it comes to retirement planning. Auto IRAs may open a new route to financial wellbeing for these workers.
Where do Auto IRAs fall short?
While IRAs are a valuable vehicle for individual retirement savings, they may be ineffective as stand-alone retirement savings vehicles.
A major drawback of IRAs are their relatively low contribution limits. Individuals can contribute only $6,000, plus a catch-up if age 50 or older, to their IRA each year. Compare that to the 401(k) limit of $20,500, plus a catch up if age 50 or older. Saving early and saving often are important, but so is saving enough.
Another drawback is taxability. In a traditional 401(k) plan, employee deferrals reduce taxable income. In many state Auto IRA programs, enrollees are only given an after-tax Roth IRA option. This means that, while a worker’s savings will be tax free at retirement, their taxable earnings today will be higher than if they had contributed to a traditional 401(k).
Since IRAs are owned by individuals, employers cannot make contributions. A traditional, safe harbor 401(k) account requires a match of at least 4% of salary. Auto IRAs cannot have such a provision.
Gaining state and federal support
State retirement programs became popular in 2017, with the launch of the nation’s first Auto IRA in Oregon. Since then, three additional states, California, Illinois, and Connecticut have launched their own programs. They will be joined in the coming years by six other states and two cities, currently in varying stages of implementation.
Currently the following states are enacting an Auto IRA program:
- California (active)
- Colorado
- Connecticut (active)
- Illinois (active)
- Maine
- Maryland
- New Jersey
- New York
- Oregon (active)
- Virginia
Congressional support for a nationwide Auto IRA program is uncertain. Members of the House Ways and Means Committee including Chairman Richard Neal (D-MA) have shown support for an Auto IRA program. However, support for such a program seems to closely follow party lines.
Regardless of national success, Auto IRAs appear to be working. According to Georgetown University, three state Auto IRA programs have already facilitated over $423M in retirement savings.