Can the Auto-IRA Really Improve Retirement Security?

Remember the auto-IRA? It's a good--but modest--idea for improving retirement security that President Obama has been trying to get going since 2010. Auto-IRAs would cover millions of workers who don't have 401(k)s on the job--mostly lower-income workers at small businesses. But Congress has refused to cooperate, so the White House threw in the towel on the idea.

Instead, the federal government will help states close the coverage gap. The Obama administration recently announced that the U.S. Department of Labor (DOL) will clear the regulatory path for states to create their own auto-IRA plans for workers who aren't offered retirement plans on the job. The move is a tacit recognition that the auto-IRA needs a new road map--and that the MyRA account launched by the administration through executive action is too limited in scale to make a meaningful impact.

A handful of states--California, Illinois and Oregon among them--already have approved auto-IRA plans, and roughly half of the remaining states are examining the idea.

The administration's shift is a big deal, because states have been waiting for the DOL to indicate whether state plans would be governed by the Employee Retirement Income Security Act (ERISA), the federal law that sets standards for private-sector pension plans.

Concerns about regulatory burdens for employers--and their possible fiduciary responsibilities under the plans--led states to include clauses in their legislation stating that the plans wouldn't proceed if they were deemed to be ERISA plans. The states argue that fiduciary liability can be taken on by the boards governing the plans and by third-party financial-services companies that are hired to run them. What's more, the DOL was reluctant to let the plans proceed without ERISA protections. However, the process now appears to be on a fast track.

The Center for Retirement Research at Boston College estimates that at any given point, only half of U.S. private-sector workers participate in a retirement plan. The largest coverage gaps can be found at small employers, who don't want to deal with the cost or regulatory burden of administering 401(k) plans.

In Illinois, 72% of private-sector workers in high-turnover, low-wage industries lacked access to a retirement plan, according to a study by the Woodstock Institute. By comparison, 70% or more of high-income workers are covered, industry data suggests. The study--based on industry and federal government data--found that Illinois' auto-IRA plan, the Illinois Secure Choice Savings Program, could potentially serve 2.5 million workers.

California was the first state to pass legislation authorizing a public retirement plan, and it has been waiting for regulatory clarification for nearly three years. Its plan is called the Secure Choice Retirement Savings Program, and it would automatically enroll workers without a workplace plan in a state-sponsored IRA, most likely in a target-date fund. Workers could opt out; employers would be required to enable regular payroll deductions, but wouldn't be required to make any matching contributions. Plan investments would be professionally managed through outsource arrangements with financial-services companies.

Encouraging people to save for retirement should be a mom-and-apple-pie idea. But Secure Choice plans have faced opposition from state business associations and some segments of the financial-services industry, notably insurance companies. They oppose programs with mandatory-participation features on ideological grounds, and argue that retirement accounts already are available universally, either through the workplace or IRAs.

"Moreover, people choose not to save for a variety of reasons other than accessibility, including competing financial demands," notes SIFMA, the securities industry lobbying group, in a recent blog post. "Establishing state-run plans won't change this fact--but better education about the importance of saving might."

That last argument misses the power of automatic enrollment and default contribution--features that have been adopted rapidly by workplace plans with positive results. Behavioral economics points to a lack of planning skills, inertia, and uncertainty when facing complex choices as key reasons people don't take the initiative to save for retirement on their own.

In the plans administered by Vanguard, adoption of auto-enrollment has grown 50% since 2009, and 60% of all participants were signed up via auto-enrollment last year. That is boosting overall participation rates in retirement-savings plans--89% of auto-enrolled participants stay in their plans once enrolled, Vanguard reports.

While it's true that auto-IRAs can help more people to start saving, their impact will be minimal. The households they aim to serve tend to have lower incomes, and since auto-IRAs don't have matching-contribution features, the dollars accumulated in these accounts may be modest.

The Employee Benefit Research Institute estimates that, in a best-case scenario (where no one opts out), adding an auto-IRA for households currently ages 35-39 would increase the odds of a "successful" retirement--that is, not running out of money--by 8.4%. Auto-IRAs are not a complete answer to the retirement-savings gap, but they are a start. (I've argued elsewhere that a far better approach to bolstering retirement security for this segment is to expand Social Security).

If all goes according to plan, California and Illinois expect to begin enrolling retirement savers in 2017, and a handful of other states will follow suit. That raises the possibilities that we could have a checkerboard auto-IRA map of the U.S., with "have" and "have not" states. Or, experimentation at the state level could set the stage for a national auto-IRA.

"I think as soon as five states create these plans, the financial-services industry will ask Congress to preempt them with a single national model," says Joshua Gotbaum, former director of the Pension Benefit Guaranty Corporation, the federally sponsored agency that insures private-sector pensions, currently a guest scholar at the Brookings Institution.

Mark Miller is a retirement columnist and author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work, and Living. The views expressed in this article do not necessarily reflect the views of Morningstar.com.