How Much Might Automatic IRAs Improve Retirement Security for Low- and Moderate-Wage Workers?

Abstract

Automatic individual retirement accounts (IRAs) could significantly boost retirement savings for millions of low- and moderate-wage workers. A proposal embraced by the Obama administration would require most employers that do not offer retirement plans to establish IRAs for their employees and automatically direct a portion of pay into the accounts, unless employees opt out. Our results, based on the Urban Institute’s microsimulation model, show that automatic IRAs would boost retirement incomes for as many as half of low-income retirees and three-fifths of moderate-income retirees. For both groups, mean age-70 incomes among those who gain would increase by nearly a fifth.

Introduction

This brief examines the potential of automatic IRAs to improve retirement security for low- and moderate-wage workers. The results, based on the Urban Institute’s microsimulation model, show that automatic IRAs can significantly increase retirement plan coverage and economic security for low-income retirees, at little cost to business or the federal government.

Automatic IRA Proposal

Many Americans fail to save for retirement. About 40 percent of all wage and salary workers ages 25 to 59 in 2009 worked in jobs that didn’t offer retirement plans (Butrica and Johnson 2010). Another 16 percent of workers with offers did not participate (Butrica and Johnson 2010). And many people—particularly those with limited resources—withdraw funds from their 401(k)s and IRAs during their working lives, and even cash them out completely. Butrica, Zedlewski, and Issa (2010) find that 8 percent of retirement account owners made at least one withdrawal between 2004 and 2005. Withdrawals were more likely among African Americans, those without college degrees, and those with little or no assets.

Many workers eligible for retirement plans do not participate simply because they never bother to enroll. Increasingly, employers are overcoming this inertia by automatically enrolling new employees. The early results are promising: many studies document much higher participation in retirement plans for which participation is the default rather than an opt-in choice (Beshears et al. 2009; Choi et al. 2004; Madrian and Shea 2001). But automatic enrollment does not help workers whose employers do not offer plans.

The automatic IRA, conceived by Mark Iwry of the Brookings Institution and David John of the Heritage Foundation, could boost retirement savings for millions of workers not offered employer-sponsored retirement plans (Iwry and John 2007). The proposal calls for employers with more than 10 workers that do not offer retirement plans to set up IRAs for their employees. Employers would automatically deduct a percentage of workers’ pay and deposit it into their IRAs, but employers would not be required to contribute themselves. Employees could opt out of this retirement savings deduction or change the amount deducted. Automatic IRAs would be provided by the same private financial institutions that currently offer IRAs and be subject to the same contribution limits and regulations as existing IRAs.

Several bills have been introduced in Congress to create automatic IRAs. Some stipulated that workers participating in an automatic IRA or 401(k) would have their federal saver’s credit automatically deposited into their retirement savings account. The saver’s credit uses federal tax credits to match low- and moderate-income workers’ contributions to their retirement savings accounts. Currently, however, the saver’s credit is nonrefundable, so low-income people without any tax liability would not benefit. To address this shortcoming, some automatic IRA bills would expand the saver’s credit by making it fully refundable.

The Obama administration has advocated creating automatic IRAs and expanding the saver’s credit to help low- and moderateincome families build retirement savings. Although the automatic IRA was included in President Obama’s FY2012 budget request, the expanded saver’s credit was dropped (Gale and John 2011).

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