The Auto-IRA: A Possible Solution to PA’s Looming Retirement Crisis

From PA Treasury

Read Entire PA Treasury Note (with informational graphics)

In the last Treasury Note, we laid out the details of Pennsylvania’s retirement crisis. Too many private sector workers do not have the savings needed for retirement. This is of particular concern in Pennsylvania because the state has a much larger aging population than most. Collectively, workers’ lack of retirement savings will cost the state billions of dollars in social assistance and lost tax revenue.

In 2017, Treasurer Torsella convened the Task Force on Private Sector Retirement Security to study the problem in depth. It was a bipartisan group of stakeholders that included the Republican and Democratic chairs of both the Pennsylvania House and Senate finance committees. The Task Force held 4 hearings across the state in which it heard from experts in retirement security research, financial service providers, Pennsylvania small business owners, and officials from other states that are implementing their own plans. After many hours of testimony and deliberation, the Task Force ultimately reached broad consensus that the state must do something to address the problem, and that the auto-IRA is the policy option that makes the most sense.

Put simply, the auto-IRA is a means for workers to more easily save their own money. Similar to the 401(k) that many employers offer, a percentage of employee pay is deducted for investment in the employee’s retirement account. Through the state-facilitated auto-IRA program, all employers who do not already offer a retirement savings plan would automatically enroll their employees in the auto-IRA. The state would partner with employers to raise awareness among the working population about the plan prior to rollout, as well as to disclose employees’ right to opt-out. Just as all employers must deduct a certain percentage from employee pay for taxes and Social Security, employers would set up a new deduction that would send a portion of participating employees’ pay to their new auto-IRA account. In contrast to 401(k)s, employers do not make contributions to their employees’ auto-IRA accounts, as auto-IRAs are not subject to the Employee Retirement Income Security Act of 1974 (ERISA).

Within each participating worker’s auto-IRA account, $1,000 would be safeguarded in a capital preservation fund. This would shield the first $1,000 a worker saves from the ups and downs of the investment markets, providing the assurance that—while retirement investing is a long-term strategy that flourishes over time thanks to compound interest—a portion of their savings will be preserved even if the market dips in the short term. The rest of workers’ savings would go into a default low-cost investment vehicle, such as a target date index fund. If an employee decides they want to make changes to the default account settings they are enrolled in—for example default contribution rate or specific investment vehicle—they can always change it to fit their personal preferences and goals.

Another important feature of the auto-IRA is that it is portable. Since few people work for the same company their whole career anymore, portability allows workers to continue to save in the same plan if they switch employers, without having to worry about rolling the account over.

The auto-IRA can best be described as a public-private partnership. Through the bid process, state government selects a private investment manager and vets the investment vehicles the manager offers to program participants. While the program would require appropriations at the outset for startup costs, those costs would be repaid as the program ultimately becomes self-funding. The College and Career 529 Savings Plans provide a good example of how Pennsylvania has already successfully implemented this type of program for over two decades. And just like in the 529 Plans, the assets in the program belong entirely to the individual account owners, not the state.

As described in the Task Force’s report, lack of access to a workplace retirement plan is a key cause of retirement insecurity.

About 77% of workers with access to a workplace plan participate, while only about 5% of workers who lack workplace access will open their own independent account. In short, when workers have an easy, automatic way to save some of their income before it even appears in their paycheck, they are much more likely to save for retirement—at least 15 times more likely, according to AARP. 

The auto-enrollment aspect of the auto-IRA makes workplace saving that much easier because workers do not have to take any action to begin saving. Many workers with the best intentions to save may be overwhelmed and ultimately deterred by the time and effort it can take to research investment decisions. However, a growing body of behavioral economics research tells us that the easier it becomes for people to save through mechanisms like automatic payroll deduction, the more savings they accumulate. That means we can use auto-enrollment to harness the inertia many of us face when making financial decisions to ultimately improve people’s lives. 

As several small business owners stated at a Retirement Task Force hearing, employers face significant obstacles in establishing a retirement plan such as a 401(k) for their workers—particularly cost, liability, and compliance obligations related to ERISA. A state-facilitated auto-IRA program would bring the remaining employers who do not offer a retirement plan into the fold without those burdens, thereby evening out plan coverage gaps so that all Pennsylvanian workers would have workplace access to a retirement savings plan.

From inception, the auto-IRA has represented a bipartisan effort to address the country’s lack of retirement savings. It was first proposed in a 2006 article written by David John of the Heritage Foundation and J. Mark Iwry of the Brookings Institution. Since then, it has been adopted into law by six states. California, Connecticut, Illinois, Maryland, New Jersey, and Oregon. Notably, the Maryland auto-IRA bill was signed into law by a Republican Governor in May 2016, where it passed the Senate with a unanimous vote from all 32 Democrats and 14 Republicans. This year, Oregon’s standalone compliance legislation passed with bipartisan support. It was also supported by the Oregon Farm Bureau and the Oregon Association of Nurseries.

The president and CEO of the American Council of Life Insurers Susan Neely recently gave a public endorsement of a federal auto-IRA bill, stating “It is a market-based solution that can help more people save more of their own money for the good of their families’ futures.”

Numerous other conservative individuals have spoken in favor of the auto IRA, including former chairman of President Reagan’s Council of Economic Advisors, Martin Feldstein, Ramesh Ponnuru of the American Enterprise Institute, and journalist George Will.

At a Retirement Task Force hearing, several small business owners testified that it is important to them to offer retirement benefits to their employees, both for competitiveness and because it’s the right thing to do. However, they also noted there are many challenges involved with doing so—particularly cost, complexity, and liability risk. Results from a recent AARP survey of Pennsylvania businesses with 100 or fewer employees support these remarks. According to the survey, nearly 9 in 10 of PA small business owners agree that state lawmakers should support the creation of a state-facilitated retirement savings option. In addition, three quarters of respondents favored a ready-to-go retirement plan over having to stand one up on their own. 

In contrast to most employer-sponsored plans, a state-facilitated auto-IRA involves minimal obligations for employers. Under the plan, employer obligations would be limited to simply adding an extra payroll deduction for all employees who do not opt-out, maintaining and sharing payroll deduction records with the state, and distributing information to employees. Because the auto-IRA is not subject to ERISA, employers cannot contribute to employees’ accounts. They also do not have to take on any of the administrative paperwork or liability risk that comes with ERISA.

In today’s tight labor market, the auto-IRA allows small businesses a step up in offering retirement benefits to potential hires without taking on the burdens of an employer-sponsored plan. This improves their competitiveness and the Commonwealth’s economy.