Best-laid plans too often go awry, which is the case with the original mandate for individual retirement accounts.
IRAs are popular retirement rollover options, but they have not caught on as retirement savings vehicles for employees who don’t have access to employer-sponsored plans.
That could change if smaller employers begin to introduce payroll-deduction IRAs, also known as workplace IRAs.
When IRAs were first established in the 1970s, they were expected to satisfy two key retirement needs:
- IRAs would provide Americans who were not covered by retirement plans at work with the opportunity to save for retirement in tax-deferred accounts available through private financial institutions.
- IRAs would give retirees, and workers who were changing jobs, a means of preserving the tax benefits of employer-sponsored retirement plans by rolling their savings into IRAs.
On the face of it, IRAs appear to be an undisputed success. During 2016, about $7.5 trillion were invested in traditional and Roth IRAs, and more than one-third of U.S. households owned an IRA, according to the Investment Company Institute. But the stats don’t tell the story.
IRAs have not met savings expectations
Just 14 percent of American households have made contributions in recent years to IRAs, and many already participate in employer-sponsored plans, according to the Center for Retirement Research at Boston College (CRRBC). In general:
- 6 percent are higher-income dual-earners who save in 401(k) plans, as well
- 6 percent are moderate-income singles or one-earner couples, often with 401(k) plans
- 2 percent are higher-income entrepreneurs without 401(k) plans
ICI believes IRAs fell prey to investor inertia in the late 1980s.
Before that time, IRAs were ‘universal.’
All workers younger than age 70 ½ were allowed to make tax-deductible contributions, and IRA contributions reached all-time highs. The rules changed in 1986, and contributions fell precipitously.
“Reintroducing limitations on deductible contributions, along with the added complexity of determining eligibility, drastically reduced deductible IRA contributions and reduced participation among many households who continued to be eligible,” ICI wrote.
Overcoming investor inertia with payroll deduction IRAs and automatic enrollment
The need to provide Americans who are not covered by retirement plans at work with a means to save for retirement has not changed.
Fully 55 million American workers do not have access to employer-sponsored retirement plans. In many cases, they work part-time or are employed by smaller businesses that don’t have the resources to offer retirement plans.
While many are searching for a new solution to the problem, we believe IRAs may still be the answer. We simply have to find ways to overcome investor inertia. It’s not easy, but the retirement industry has found effective ways to address plan participant inertia and those methods can be applied to IRAs.
For instance, workers with access to payroll deduction plans at work are 15 times more likely to save for retirement, so payroll deduction may be a sound choice for IRAs. Also, retirement plan enrollment rates are significantly higher for plans with automatic enrollment features than for plans with voluntary enrollment. The same might prove true for IRAs.
Breathing new life into old ideas with ‘Workplace IRAs’
CRR recently suggested that state or federal government should automatically enroll people who don’t have workplace plans in IRAs (with opt out provisions) to help close the retirement savings gap.
While government administration is a relatively new idea, automatic enrollment in IRAs is not. The Heritage Foundation discussed the possibility in 2006:
“The automatic IRA would feature direct payroll deposits to a low-cost, diversified individual retirement account. Most American employees not covered by an employer-sponsored retirement plan would be offered the opportunity to save through the powerful mechanism of regular payroll deposits that continue automatically (an opportunity now limited mostly to 401(k)-eligible workers).”
The group also suggested a tax credit be provided to employers if they made regular payroll deposits available to employees.
Today, the majority (86 percent) of small and mid-sized business owners support the idea of payroll deduction IRAs with automatic enrollment features that are administrated by private financial institutions, reports Pew Charitable Trusts.
We call IRAs with these features ‘Workplace IRAs.’
The Department of Labor also supports the idea. In 2016, it wrote, “A payroll deduction IRA at work can simplify the process and encourage employees to get started.”
The many advantages of payroll deduction IRAs include:
- Helping employees save for retirement;
- Providing an inexpensive plan alternative for small business owners;
- Making small businesses more competitive; and
- Eliminating reporting requirements and fiduciary responsibility (as long as the employer minimizes its involvement).
Some state governments have considered or established automatic IRA programs; however, business owners are far more resistant to the idea when federal and state governments administrate payroll deduction IRAs. More than half of business owners said they would prefer to introduce their own plans rather than rely on a government-run plan.
It’s time for Workplace IRAs
Improving retirement savings has been a national priority for decades. Introducing workplace payroll deduction IRAs with automatic enrollment features can help workers who have no access to retirement plans save for retirement. Workplace IRAs also provide smaller business owners with an inexpensive retirement plan alternative that can help improve competitiveness and provide other advantages. Workplace IRAs are a win-win solution whose time has come.
Terry Dunne is Senior Vice President and Managing Director of Retirement Services at Millennium Trust Company, LLC. Dunne has over 35 years of extensive consulting experience in the financial services industry. Millennium Trust Company, LLC acts as a directed custodian and does not provide tax, legal, or investment advice.