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Wrong on Retirement: Why the Auto IRA is a Bad Idea

Robert Hiltonsmith

The Obama administration’s FY2013 budget proposal was released yesterday, and in addition to the headline items—such as military budget cuts and “Buffet-rule” tax increases—it contained in its 256 pages several interesting proposals that flew under the radar.

One such proposal was the revival of an idea that Obama proposed on the campaign trail: the “Automatic IRA.” Under the plan, all employers who don’t offer a retirement plan will be required to enroll their employees in a direct-deposit IRA account. Very small employers—those with fewer than 10 employees—would be exempt, and the government would offer a credit to help employers with the costs of setting up an Auto IRA. The administration has touted the idea throughout the years, claiming it would help the 49 percent of workers who currently have no access to a retirement plan at work save for retirement.

I'm all for increasing retirement security—who isnt'?—but the Auto IRA won’t do that. Instead, it will force millions of Americans into an individualized retirement system that is already failing dismally, as Demos has documented in our work on 401(k)s. Shoehorning workers into IRAs, which on average have higher fees than 401(k)s, will only compound the problems of an overly privatized approach to retirement in the U.S.—while subsidizing the same industry that caused the financial crisis.

The Auto IRA is actually a policy dreamed up by the right: the brainchild of the Heritage Foundation, it is grounded in their boilerplate, conservative, market-oriented approach that has failed in so many other policy arenas.  Defenders of the Auto IRA claim that the plan would lower fees for these retirement savings vehicles by creating an IRA “exchange” that would allow employers and employees to compare plans and ostensibly choose the ones with the lowest cost. However, this claim is predicated on the assumption that consumers would have the information and know-how to properly compare plans. Given the incredible complexity of the retirement market, counting on the administration to come up with clear, fair guidelines for comparison, and then relying on the financial wherewithal of time-strapped employees and small business owners seems unreasonably optimistic.

Even if the fees were brought down, IRAs still share the same inherent flaws as 401(k)s: they expose participants to a whole host of risks, risks that hardworking Americans shouldn’t be forced to shoulder alone. Savings in 401(k)s and IRAs are exposed to the vagaries of the stock markets, and lower-than-expected returns can in turn cause participants to underestimate the amount they need to save. Participants’ savings can also be depleted by the need to withdraw from or borrow against their savings due to unexpected, costly events such as a big medical expense or divorce. Finally, saving enough for retirement requires participants in individualized retirement plans to know exactly how long they will live, or forces them to save an incredible amount to self-insure against that risk, a burden difficult or impossible for workers in today’s stagnant economy to bear.

The country’s broken retirement system is indeed in dire, immediate need of reform, but the Auto IRA will not fix the looming retirement crisis. A policy solution that would fix this crisis would have low-cost investment options that at least partially protect workers against inflation and market swings, and would also give savers a guaranteed, low-cost, inflation-protected stream of income when they retire. The Auto IRA has none of these features.

If the administration is really serious about helping Americans save for retirement, they’ll scrap the Auto IRA and pursue a solution that gives Americans real retirement security, such as one of the many policy ideas that fulfill the guidelines for a good retirement system crafted by the Retirement USA coalition, to which Dēmos belongs. One such idea is Dr. Teresa Ghilarducci’s “Guaranteed Retirement Accounts” plan (GRAs), which proposes the creation of universal, privately-invested, low-fee, tax-deductible retirement accounts that would give Americans a place to invest their savings that is protected from market risk and inflation and would the option to annuitize a portion of their nest egg at retirement, providing a stream of income for life that would insure they don’t outlive their savings.

If the administration is serious about shoring up Americans’ crumbling retirement security, it needs to urge Congress to create GRAs or a similar type of account and drop the Auto IRA, which would do little to help ailing American families, but much to subsidize the industry that caused their ailments.