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How About an Automatic IRA?

By JLP | October 30, 2007

I read an interesting editorial by Laura Tyson in today’s Wall Street Journal about different ways to get Americans to start saving for retirement. The article mentioned the automatic 401(k) and something new called an automatic IRA, which would work similar to the auto 401(k) but for small companies. From the editorial:

To help the 75 million workers who don’t have access to an employer-sponsored 401(k), a bipartisan group of legislators — led by Sens.Jeff Bingaman (D., N.M.) and Gordon Smith (R., Ore.) and Reps. Phil English (R., Pa.) and Richard Neal (D., Mass.), have introduced a bill to create an Automatic IRA. This would be a standard IRA account, but funded through payroll deductions. It would also offer automatic 401(k)-like features such as an automatic investment choice, level of contribution and enrollment. Under the proposal, employers with 10 or more employees that have been in business for at least two years would enable employees to save their own money in an IRA by using the employer’s payroll system.

The Automatic IRA allows employers to facilitate employee saving without having to sponsor a formal, ERISA-regulated retirement plan, or make matching contributions. Firms would receive a temporary tax credit to offset any initial administrative costs; either the employer or the employee could choose which financial institution would hold the money. The Retirement Security Project estimates that the Automatic IRA could increase IRA participation rates significantly from the current rate of one in 10, and could ultimately increase net national savings by nearly $8 billion annually.

I like this idea a lot. Especially when you consider the fact that there are lots of small employers who may not have the resources to set up a 401(k). Of course all this assumes that the employees can afford to save in the first place.

Topics: 401(k), Investing, IRAs, Retirement Planning | 10 Comments »


10 Responses to “How About an Automatic IRA?”

  1. Foobarista Says:
    October 30th, 2007 at 12:57 pm

    How about allowing self-managed 401Ks as a substitute for employer 401Ks? The thing I don’t like about an “automatic IRA” is that it would be subject to far lower contribution limits.

    A self-managed 401K would be an account you manage, with employer contributions in a parallel “escrow” account until they “vest”, in terms that are part of your employment contract.

    We already have self-managed 401Ks for self-employed people; making them portable for regular employees would be a huge step forward.

  2. BuildAndSucceed Says:
    October 30th, 2007 at 1:21 pm

    If it helps people who aren’t saving start saving, it’s definitely a good thing.

  3. Spokane Al Says:
    October 30th, 2007 at 1:31 pm

    I wonder if this idea will allow the employee to choose between a Roth and a regular IRA. For many of us forgoing the immediate tax break and taking advantage of a lifetime of tax free earnings combined with tax free distributions makes more sense than an IRA.

    Of course even a standard IRA is better than nothing at all.

  4. Money Blue Book Says:
    October 30th, 2007 at 1:41 pm

    I think such discussions are moves in the right direction. People aren’t taking advantage of IRAs and Roths enough so maybe a payroll deducted deferred retirement plan is the way to go for those without access to employee plans.
    -Raymond

  5. Brad Says:
    October 30th, 2007 at 1:50 pm

    I’m not familiar with the Automatic IRA, but there is an alternative to 401K’s for small businesses who can’t afford the costs of administering 401K’s. It is called a SIMPLE IRA. We have one where I work.

    It works very similarly to a 401k from the employee’s perspective. The employer has limited flexibility (i.e. how much matching they can offer, etc.) in return for lower administrative costs.

  6. Joel Says:
    October 30th, 2007 at 3:03 pm

    A few problems I have:

    It’s forced on businesses- there’s no choice involved. Yes, there’s a one-time upfront tax credit to defray the cost of setting up the plan, but this will be another ongoing paperwork burden for employers.

    Unless the employee opts out, they are automatically enrolled. I don’t like it when people’s decisions are made for them by someone else (particularly the government!).

    There doesn’t appear to be any mechanism by which a participant’s tax withholding is adjusted relative to their IRA contribution. That means more people have to wait until tax time to get more of their own money back from Uncle Sam.

  7. Kitty Says:
    October 30th, 2007 at 6:39 pm

    “There doesn’t appear to be any mechanism by which a participant’s tax withholding is adjusted relative to their IRA contribution. ”
    You can fill out W-4 to adjust your withholding levels. Yes, the employees would have to figure it out on their own, but it is not that complicated.

  8. Thinking About Retirement - A Stroll Through My Blogroll Says:
    October 31st, 2007 at 12:01 am

    [...] AllFinancialMatters has an interesting article about Automatic IRAs – I like the idea of making investing easier – but if companies move to this plan, would 401K matching be a thing of the past?  I’ll have to do some further research. [...]

  9. Blogging About ERISA - Carnival #19 Says:
    November 4th, 2007 at 8:13 pm

    [...] JLP of the All Financial Matters blog discusses Laura Tyson’s article in the Wall Street Journal on automatic IRAs in How About an Automatic IRA? [...]

  10. ira » How About an Automatic IRA? Says:
    November 5th, 2007 at 10:28 am

    [...] Read the rest of this great post here [...]

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