MONEY

Why it’s time to create an auto-IRA

Tucked in among the ambitious programs laid out in President Barack Obama’s proposed 2010 budget yesterday was a welcome provision for employees of small businesses: the creation of an automatic Individual Retirement Account (IRA). As Obama pointed out in his budget proposal, some 75 million Americans—roughly half of all workers—lack any sort of employer-based retirement plan, such as a 401(k). And that group includes most employees of small businesses.

First proposed by policy experts Mark Iwry of the Brookings Institution and David John of the Heritage Foundation, this plan would require employers that don’t currently offer a retirement plan to automatically enroll their workers in a direct-deposit IRA. Employees would be allowed to opt out. The auto-IRA has already received wide bipartisan support—Obama and Republican presidential candidate John McCain both endorsed it during their campaigns. And in 2007 a bipartisan bill to create an auto IRA was introduced in Congress.

As part of this plan, the White House budget also calls for expanding the saver’s credit, which is a tax credit for middle- or low-income workers saving in 401(k)s or IRAs, to 50% of the first $1,000 for Americans earning less than $65,000. Together these moves would increase savings participation for this group of workers from 15% to around 80%, according to White House estimates.

Will the auto-IRA be enacted? Quite possibly, given its previous support. But the plan, which is expected to cost some $55 billion over the next 10 years, has already been greeted with skepticism by some Congressional Republicans. And crucial details have not been spelled out that could prove to be dealbreakers. Under an earlier version of this plan, for example, employers would receive a tax credit of up to $250 each of the first two years they offered the auto-IRA, as way to offset administrative costs. And employee contributions would be defaulted into a low-cost investment fund, unless the worker chose an alternative investment. Neither of these features is mentioned in the White House budget overview.

If the plan does make it through Congress, it would be only a first step toward solving America’s retirement savings crisis. As we explained in our recent story “It’s Time to Fix the 401(k),” defined contribution savings plans, such as 401(k)s and IRAs, have largely failed to deliver secure retirement income—and that was true even before the market meltdown. The shortfalls of these plans were the subject of two Congressional hearings earlier this week. One, by the House Committee on Education and Labor, is just the first of a planned series of hearings on 401(k)s and retirement security. And a hearing held by Senate Aging Committee took a look at the poor performance of many target-date retirement funds, which have become the default option in most 401(k)s.

Of course, for the overwhelming majority of Americans the biggest problem has not been the type of savings plan they have, but the fact that they didn’t save at all. As a result, more than half of baby boomers are at risk of being unable to maintain their standard of living in retirement unless they put away a lot more and work longer, according to studies by the Boston College Center for Retirement Research.

Given that shortfall, the auto-IRA could make a difference, but on its own it clearly won’t be enough. The plan would enable workers to save up the maximum IRA limits—$5,000 in 2009 (up to $6,000 for those age 50 and older). That’s much less than the $16,500 ($22,000 for those age 50 and older) for 401(k) participants can stash away. Still, it’s at least a start.

– Penelope Wang

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