Thoughts on Improving Retirement Readiness

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Seventy-one percent of Americans say they do not have enough retirement savings, according to a national survey commissioned by Experian in collaboration with Get Rich Slowly[1]. I have often said the biggest retirement planning mistake is procrastination. Starting young and saving consistently is an important retirement planning technique.

The Pension Protection Act of 2006 attempted to encourage workers to start earlier by requiring employers to automatically enroll them in the company 401(k). The worker would have to “opt out” of the plan rather than having to enroll voluntarily. Nearly 10 years later, Vanguard has published a whitepaper[2] showing among new hires, participation rates more than doubled to 91% under automatic enrollment. This compares with 42% under voluntary enrollment. They also found that 8 in 10 participants increase contribution rates, either automatically or on their own.

Automatic enrollment in Illinois state-sponsored plan

State and federal government has taken notice. Illinois was the first state to pass a law requiring companies to automatically enroll their employees in a state sponsored Roth IRA if they do not offer a retirement plan. The Illinois Secure Choice Savings Program (ISCSP) will begin in 2017. The law applies to employers with 25 or more workers who have been in business at least two years. Workers can opt out if they choose. Employers with fewer than 25 employees or that have been in business for less than two years may participate voluntarily. The accounts will be funded by a 3% (or higher) after-tax deduction from their paychecks. There is no cost to the employer other than the administrative cost to enroll workers and process the payroll deduction. Employers will have no fiduciary liability.

ISCSP was passed in response to a U.S. Bureau of Labor Statistics study that found 72% of private-sector workers in high-turnover, low-wage industries lacked access to a retirement plan. Only 40 percent of households owned any type of account – IRA, 401(k) or traditional pension – down from 48% over the last 6 years. Six more states have passed similar laws – California, Connecticut, Maryland, New Jersey, Oregon, and Washington. Many other states have introduced legislation or have formed task forces to study the issue.

Other options for closing the gap in retirement plans

Others say there are better ways to close the gap, such as new low-cost, multiemployer 401(k) options for small businesses at the federal level. President Barack Obama’s MyRA program would presumably be at least one option for the single-IRA-custodian. The employer would not be required to make any employer contributions, would have no retirement plan compliance obligations, and would have no liability or responsibility for determining employee eligibility to make tax-favored IRA contributions.

Small employers (fewer than 100 employees) would be eligible for a (non-refundable) tax credit of up to $1,000/year for 3 years to defray setup costs, plus a further credit of $25 per enrolled employee (up to $250/year) for 6 years. Notably, the proposal would also increase the tax credit for small employers that do offer an employer retirement plan (including a qualified plan, SEP, or SIMPLE) from the current $500/year for 3 years up to $1,500/year instead, plus another $500/year for new plans that include auto-enrollment.

Mandatory and other auto-enrollment plans

All the focus so far has been about voluntary retirement accounts. The employer would be required to automatically enroll their workers but the worker could always opt out. There are some who think we should go further. They propose that the country introduce mandatory retirement accounts that require all workers save 3% of their income in a 401(k)-type account. The 3% savings would be in addition to the 6.2% of income all workers must currently pay in Social Security taxes. While this is only theoretical at this point, it is worth paying attention to in light of the state auto enrollment developments.

Proponents of mandatory retirement accounts have suggested the following concepts for a federal 401(k) type plan:

  • Every American worker would have a federal 401(k) account. This would ensure consistent retirement savings throughout the worker’s career.  No rollover would be required when a worker changes jobs. The new employer would pick up employee contributions to the existing account.
  • Workers would keep the funds in the accounts unlike Social Security. Their funds will be pooled and invested in long-term, strategies like the way the current Thrift Savings works for federal employees.
  • The only distribution option at retirement would be a life annuity. This would guarantee a continuous stream of income and avoid potential investment mistakes or excessive spending.
  • This plan keeps accounts under personal control, distributing savings based on the amount invested. It would not impact the federal budget or raise taxes.

There are some who see mandatory retirement accounts as a possible solution to the looming Social Security crisis. It could possibly give younger workers more control over their retirement future than Social Security currently offers. When to retire would still be up to the worker. The amount of income in retirement would also depend on how much the worker chooses to set aside during their career. Of course, we all have these options now. It will be worth following the success of ICSCP in Illinois to see if they have as much success with auto enrollment of IRAs as the 401(k) enrollment has experienced.

Rick’s Tips:

  • Participation rates have more than doubled since 401(k) automatic enrollment requirements became effective.
  • The Illinois Secure Choice Savings Program (ISCSP) is the first state-sponsored IRA plan requiring auto enrollment by eligible employers.
  • A federal mandatory retirement account program could require all workers save 3% of their income in a 401(k)-type account.

[1] The Washington Post, September 26, 2016

[2] Automatic Enrollment: The power of the default, Vanguard Research, January 2015

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