josh gotbaum, who’s worked at senior levels of both government and business, is a guest scholar at the Brookings Institution. This article is adapted from his analysis on the Brookings website.
Published July 7, 2021
Long before she died at age 92, my mother ran through her retirement money. She wasn’t unusual; the non-partisan Employee Benefit Research Institute estimates that some 4 out of 10 of us will run out of money in retirement.
Why does this happen to so many? One reason: it’s easy to spend and much harder to save. Many people have no retirement savings plan where they work. Indeed, at least 50 million Americans (roughly a third of all employed full time) have no workplace savings beyond Social Security.
Most people just don’t save very much on their own. And there’s solid evidence that the most effective way to coax people to save more is, first, to require employers to offer savings plans and, second, to automatically enroll employees in the plans (from which they can opt out by filling out a form).
The financial services industry points out, accurately, that it offers thousands of savings plans, but most small businesses won’t have anything to do with plans regulated by Washington under the Employee Retirement Income Security Act of 1974 (ERISA), whether traditional pension plans or 401(k) tax-favored savings accounts. They don’t want to be saddled with contributions or an employee match, with the administrative costs and the regulatory requirements. Members of Congress have repeatedly proposed requiring reluctant employers to offer payroll savings, but there’s steadfast bipartisan opposition to such a mandate.
Bribes to Offer Traditional Retirement Plans Fail
Recognizing the depth of business opposition, Congress has tried carrots, repeatedly offering employers both eased regulation and generous tax preferences to start ERISA plans: tax credits of $250 per employee (up to $5,000 total) for 3 years, plus a $500 auto-enrollment startup credit.
But this initiative, well intentioned and bipartisan, hasn’t accomplished much. According to EBRI, the SECURE Act of 2019, the most significant retirement law in over a decade, will reduce the retirement shortfall by only about 3 percent. Most small businesses just won’t sign up, it seems, even for ERISA-lite.
How About a Non-traditional Retirement Plan: the IRA?
If we’re going to get to adequate universal savings, therefore, we need something that doesn’t come with ERISA’s reputational baggage. My candidate: the old-fashioned individual retirement account. IRAs, which permit tax-deferred savings, have been around for almost half a century. They’re no one’s idea of an ideal retirement program – they don’t even allow employer contributions and lack many ERISA protections – but they can get the job done. And, while Washington dithered, several states have figured out how to make them work.
State “secure choice” auto-IRA programs were designed to overcome small business objections: they involve no employer contributions, do not charge employers to participate and are exempt from ERISA reporting and regulatory requirements. All employers must do is provide their employee list and agree to payroll deductions for employees who don’t formally opt out. Some 300,000 people have accounts in the California, Illinois, Oregon and Massachusetts in which the programs are up and running, thus far accumulating more than $250 million. A survey of businesses using Oregon’s program found almost three-quarters accepted the approach, and many more such programs are in the works.
In essence, auto-IRAs can facilitate general saving, not just saving for retirement.
At the same time, the state programs offer better retirement security than private IRAs run solely by financial institutions. They are operated using professional private management, but on a larger scale and thus at lower per-account costs. In addition, because the programs have legal fiduciary obligations to savers under state laws, they must pay attention to savers’ needs in ways that firms offering private IRAs do not. Maryland’s program, expected to open its metaphorical doors this December, will offer both a “rainy day” emergency savings account and, at retirement, the choice of an automatic monthly check and other options. (Disclosure: I chair Maryland’s program.)
IRAs have other advantages over employer-based plans. For example, they’re portable: people can keep contributing to the same account when they either change jobs or add a second.
IRA programs can also be used for more than just retirement savings. Those that are designed as Roth IRAs (where contributions are not tax deductible but earnings are untaxed) allow withdrawals of principal without tax penalties. That means they can be used both for retirement savings and for emergency needs, too. In fact, each state auto-IRA program thus far includes a separate account, generally invested in money market funds, that can cover short-term needs while preserving the separate retirement funds. In essence, auto-IRAs can facilitate general saving, not just saving for retirement.
What’s Missing? A Tax Credit for Employers to Use IRAs
For businesses that offer no retirement program, the primary reason cited by the aforementioned survey is cost. Even though the state auto-IRA programs do not charge, about a quarter of employers still report significant out-of-pocket costs. Recall that Congress does provide tax credits if businesses start ERISA plans, but not IRAs – the one form of workplace savings that, ironically, small businesses are most likely to accept. Congress can and should close this gap.
Should Uncle Sam Support both IRAs and ERISA Plans?
Yes. The current program of ERISA-only employer tax credits could be modified in a way that maintains the nation’s strong preference for employer contributions via ERISA plans yet encourages use of IRAs where companies are otherwise unwilling. Here’s how:
● To encourage employer contributions and use of ERISA plans, provide the largest credit for starting or joining an ERISA plan and providing an employer match.
● Provide a lesser incentive for joining state-created fiduciary auto-IRA programs and a still smaller but substantial payment for a private auto-IRA.
● The tax credit should be a fixed amount and not limited to employer out-of-pocket expenses. Otherwise, the option that is lowest cost overall and lowest cost to employers – the state auto-IRA programs – will instead be seen by them as most expensive.
● Since state auto-IRA programs generally charge account holders much lower fees than private IRAs, the credit should be greater for the state-sponsored programs.
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Bipartisanship may be on life support in Washington, but it’s not dead. The auto-IRA was originally bipartisan, and modest federal tax credits for employers to offer auto-IRAs could appeal to both parties. Democrats can point to the expansion of retirement and emergency savings coverage. Republicans can point out that this will be accomplished without imposing a mandate on small businesses. And tens of millions of hardworking middle-income Americans who feel left out will get a greater share in an increasingly prosperous economy.