Automatic IRAs -- a Quick Fix for Workers Without Pensions?

By Albert B. Crenshaw
Sunday, February 19, 2006

For the past year or two, the turmoil in the U.S. private pension system has captured headlines and sent shivers through many households.

But for roughly half of U.S. workers, failing pensions aren't a concern. They don't have pensions -- or any employer-sponsored retirement plan -- to worry about.

They do have old age and retirement to face, however, and policymakers increasingly fear that many of those workers, who today number about 71 million, will live out their final years with only Social Security income to support them.

Already, about 20 percent of retirees have income only from Social Security even though that program was not designed to provide full retirement income. David C. John of the Heritage Foundation said last week: "We cannot assume . . . that Social Security is going to provide any more benefits [in the future] than it does now."

"Odds are" that, as a percentage of pre-retirement income, it may provide less, John said.

To try to head off what could become an explosive growth of poverty among the elderly, experts across the political spectrum have been looking for ways to expand retirement saving that really work for low-income families.

Last week, a group covering much of the political waterfront -- comprising the Heritage Foundation, the Retirement Security Project (which is funded by the Pew Charitable Trusts and affiliated with the Georgetown University Public Policy Institute and the Brookings Institution) and AARP -- proposed an idea they think would work: automatic IRAs.

The brainchild of John and J. Mark Iwry, a former Clinton administration official affiliated with Brookings, the automatic IRA would have employers withhold a portion of each employee's pay and forward it to an individual retirement arrangement, much as employers withhold taxes and forward them to the Internal Revenue Service.

Worker participation would be voluntary, but plans would be designed to encourage them to join. Employers could have employees elect in or out of the program -- forcing them at least to make a conscious decision -- or it could enroll workers automatically unless they opt out.

Contributions could be transferred to a specific IRA designated by the employee, much as is done with direct deposit of paychecks, or the employer could choose a financial institution to receive the contributions and either forward them to the employee's IRA operator or provide IRA services itself. But because lots of small accounts might not be very appealing to banks, mutual funds and other institutions, Iwry and John suggest that the federal government could contract with a single private institution to receive the contributions when neither the employer nor the employee has made a choice.

That institution would operate accounts for workers in a way analogous to federal employees' Thrift Savings Plan.

The authors acknowledge that there are many obstacles to saving, especially for lower-paid workers, but say "these obstacles can be overcome by making participation easier and more automatic," much the way automatic enrollment and investment defaults are being used to boost 401(k) plan participation.

The plan also envisions having entities that hire individuals as independent contractors provide automatic IRAs, with contributions deducted from their payments.

To get employers to go along, Iwry and John propose a combination of carrot and stick.

Under their plan, all but the smallest and newest employers would be required to offer automatic IRAs to their workers unless the employer already offers, or chooses to offer, a conventional retirement plan such as a Simple IRA, 401(k) or traditional pension.

Employers would be entitled to a temporary tax credit -- $250 or $300, the plan suggests -- to offset start-up costs, which Iwry and John think would be modest because many employers already have or contract for automated payroll systems, and because employers would be acting merely as conduits for contributions, not maintaining retirement plans.

Thus, there would be none of the rules that many companies, particularly small ones, complain about. An employer would not have to make contributions, hold assets, meet various anti-discrimination and other rules, or determine whether employees are eligible.

Instead, automatic IRAs would be just that: IRAs, governed by the rules that apply to those accounts, including the annual contribution limits, which currently are $5,000 for workers 50 and older, and $4,000 for younger workers. (Iwry and John don't envision a Roth-type option, however.)

"For many if not most employers, offering direct deposit or payroll deduction IRAs would involve little or no cost," the authors said.

And, with automatic IRAs, "employers can promote saving even if they are not ready to sponsor a [conventional retirement] plan," Iwry said. It would also give such employers something to offer workers for retirement, rather than having to tell potential hires that there's nothing.

If the government were willing to help, the automatic IRAs could be matched to a program for low-income workers in which, say, the first $500 of contributions could be matched by the employer, which could then recover its money through a tax credit.

Iwry said he and John hope ultimately that automatic IRAs would encourage employers to "graduate" to "real" retirement plans, perhaps because workers get a taste of saving and find they'd like a plan with a higher limit. Simple IRAs, for example, allow $10,000, and 401(k)s $15,000 (plus a "catch-up" for those 50 and up) -- "a nice laddered set of incentives," Iwry said.

The plan has already attracted favorable notice from a number of experts and interest groups. Peter R. Orszag of the Brookings Institution called it a "powerful and pragmatic proposal" likely to result in a net increase in saving. That is in contrast to most tax-favored saving programs, which he said attract mostly savings that would have been made anyway.

David Certner of AARP called it "the right proposal at the right time."

Iwry and John said that although there would be a cost to the government, as yet uncalculated, their plan is drawing bipartisan interest in Congress, and they are optimistic that it or some version of it would become law.

And the sooner the better.

John said: "As time goes on . . . the retirement futures of our kids are going to depend, to a large extent, on how they put aside resources from the very beginning."

* * *

Victims of hurricanes Katrina, Rita or Wilma who want to claim disaster-related losses on their 2004 tax returns, rather than 2005 returns, will have until Oct. 16 to decide, the RS said last week.

The original deadline for choosing to go back a year -- when a taxpayer may have had more income -- was the due date of this year's return, April 17.

To speed processing of such claims, taxpayers should write the name of the hurricane in red at the top of their return. Those who have already filed their 2004 returns may file amended returns (Form 1040X for individuals).

* * *

President Bush last week signed into law a bill making changes in the federal deposit insurance system, which protects depositors up to certain limits when banks fail. The limit remains $100,000 for most accounts but rises to $250,000 for some retirement accounts.

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