Automatic-Enrollment IRAs Get A Test Run In California
With all of the controversy over entitlement reform, there's one thing both sides can agree on: Social Security alone does not provide enough money for a comfortable retirement. For these workers, the Obama administration is proposing automatically enrolling workers in IRAs through their employers.
California adopted a version of this last year. Democratic state Sen. Kevin de Leon sponsored the bill to automatically enroll workers in an individual retirement account. The inspiration, he says, was his Aunt Francisca, who's 74.
"She's my second mother. She's the woman who made me dinner and breakfast, and she's still a housekeeper in one of the wealthiest enclaves in America," de Leon says. "I send her a check on a monthly basis, and she receives her Social Security check, but it's simply not enough for her to pay the rent, to put the food on the table, to pay for her medication."
A lot of kinks have to be worked out before California's automatic IRA goes into effect, but basically it would work like this for companies that don't offer private retirement plans: 3 percent of a worker's paycheck would automatically be sent to a conservatively managed retirement fund, though who will be in charge of it hasn't been determined yet. Employers wouldn't have to do anything but deduct and forward the money — the same way they handle taxes.
A worker who didn't want to participate could opt out. But that automatic enrollment is the key, says Richard Thaler, a behavioral economist at the University of Chicago.
"The only way most humans are able to save for retirement regularly is by having money taken out of their paycheck before they get a chance to spend it," Thaler says. "That is old-fashioned wisdom that is still true."
Studies back it up. When participation in a retirement plan is automatic, more people save.
"The differences are quite dramatic. In a company that has a 401(k) plan, most people figure out eventually that it's a good idea to join, but some people just never get around to it," Thaler says. "If they are automatically enrolled, signup rates are over 90 percent."
The idea for the automatic IRA has been floating around in policy wonk circles since 2006, when it was jointly proposed by David John of the conservative Heritage Foundation and Mark Iwry, then of the liberal Brookings Institution and now in the Obama administration's Treasury Department. It's been part of the Obama administration's budget every year since he was elected. In his first term, it took a back seat to health care changes. But at a recent congressional hearing, Treasury Secretary Jack Lew touted the idea as a way to get people to save more.
"One way to put that carrot out there would be to have auto IRAs, where people automatically signed up can opt out, so that people get in the practice of saving for their retirement," Lew said. Under the administration's proposal, employers who have been in business for at least two years and have more than 10 workers but do not offer retirement plans would be required to offer an automatic IRA option to employees.
Most people agree that saving for retirement is a good thing. However, Aliya Wong, executive director of retirement policy at the U.S. Chamber of Commerce, says "creating a mandate for employers is not the right way to go."
She says there's another reason the chamber opposes the Obama administration's proposal: It would require each employer to pick a company to manage the IRA. She says that makes employers legally vulnerable.
"The worker 20 years down the road looks back and says, 'I don't think that was a good investment' or 'I could have earned more.' And whether it's a viable claim, once they bring that claim, you've already started the cost of having to fight that," Wong says.
Nevertheless, about a dozen states have taken a look at starting automatic IRAs. They're attractive because they're true individual retirement accounts, not public pensions. The taxpayer is not left holding the bag. De Leon believes it's more likely that automatic IRAs will be adopted by the states rather than by Congress.
In Washington, D.C., "it's a little difficult to get this done right now, and there's a lot of dysfunction there," de Leon says.
But lawmakers in Washington and in state capitals may want to see how California's experiment works out before taking action — and the California law probably won't take effect before early 2015.
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